Rolling Over Funds from an Employer Retirement Savings Plan: What You Need to Know
Why consider a rollover?
When you roll over a distribution from a 401(k), 403(b), or governmental 457(b) plan, you generally don't pay any taxes until you receive a distribution from the new plan or IRA. If you take a distribution but don't roll it over, it will be subject to federal (and possibly state) income taxes (except for any after-tax contributions you've made); and if you haven't yet reached age 59½, you may also be subject to a 10% early distribution penalty tax unless you're eligible for an exception.1 If you take a cash distribution, you're also foregoing any further tax-advantaged growth; and if you spend the funds, you may not have sufficient assets to last throughout retirement.
Reasons to roll over to an IRA
- You generally have more investment choices with an IRA than with an employer plan. You typically may freely move your money around among the various investments offered by your IRA trustee, and you may divide your balance among as many of those investments as you want. By contrast, employer plans typically give you a limited menu of investments (usually mutual funds) from which to choose.
- You can freely move your IRA dollars among different IRA trustees/custodians. Unlike indirect (60-day) rollovers between IRAs, which are generally limited to one in any 12-month period, there is no limit on how many direct, trustee-to-trustee IRA transfers you can do in a year. This gives you flexibility to change trustees often if you are dissatisfied with investment performance or customer service. It can also allow you to have IRA accounts with more than one institution for added diversification. With an employer's plan, you cannot move the funds to a different trustee unless you leave your job and roll over the funds.
- An IRA may give you more flexibility with distributions. The distribution options available to you and your beneficiaries in an employer plan are typically more limited. With an IRA, the timing and amount of distributions are generally at your discretion (until you must start taking required minimum distributions, if applicable).
- If you've made Roth contributions to your 401(k) or 403(b) plan, those contributions (plus any investment earnings on them) will be subject to required minimum distribution (RMD) rules after you turn 72 (or after you retire, if later, if you own 5% or less of your employer).2 You can avoid the RMD rules by rolling your Roth contributions over to a Roth IRA (Roth IRAs are Page 2 of 5, see disclaimer on final page January 21, 2022 not subject to the lifetime RMD rules).
- You can use an individual retirement annuity to effectively annuitize all or part of your employer plan benefit. This can be helpful if your plan doesn't provide an annuity option.
Note: Before investing in a mutual fund, carefully consider the investment objectives, risks, charges, and expenses of the fund. This information can be found in the prospectus, which can be obtained from the fund. Read it carefully before investing. Diversification alone cannot guarantee a profit or ensure against the possibility of loss. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any strategy will be successful.
Reasons to leave in, or roll over to, an employer's retirement plan
- Many employer-sponsored plans have loan provisions. If you roll over your retirement funds to a new employer's plan that permits loans, you can generally borrow against your vested balance in the new plan, including the amount rolled over, if you need money. You cannot borrow from an IRA — you can only access the money in an IRA by taking a distribution, which may be subject to income tax and penalties.
- A rollover to another employer plan may provide greater creditor protection than a rollover to an IRA. Most qualified employer plans [like 401(k) plans] receive virtually unlimited protection from creditors under federal law. Your creditors cannot attach your plan funds to satisfy any of your debts and obligations, regardless of whether you've declared bankruptcy. In contrast, traditional and Roth IRAs are generally protected under federal law only if you declare bankruptcy. Any creditor protection your IRA may receive in cases outside of bankruptcy will generally depend on the laws of your particular state. If you are concerned about asset protection, be sure to seek the assistance of a qualified professional. [Special rules apply to individual (solo) 401(k) plans, governmental plans, and certain church plans.]
- Distributions from your employer plan won't be subject to the 10% early distribution penalty if you retire during the year you turn 55 or later (age 50 for qualified public safety employees). However, distributions from your IRA before you reach age 59½ will be subject to the penalty tax, unless an exception applies.
- You may be able to postpone any required minimum distributions. These distributions usually must begin no later than April 1 following the year you reach age 72.2 However, if you work past that age, are still participating in your employer's retirement plan, and own no more than 5% of the company, you can delay your first distribution from that plan until April 1 following the year of your retirement.
- While IRAs typically provide more investment choices than an employer plan, there may be certain investment opportunities in your particular plan that you cannot replicate with an IRA. Further, you may be satisfied by potentially lower-cost funds available in your particular plan, and therefore may not regard an IRA's broader array of investments as an important factor.
Special considerations for distributions from designated Roth accounts
Required minimum distributions (RMDs) are generally required from Roth 401(k)/403(b) accounts after you turn 72 (or after you retire, if later, unless you're a 5% owner). However, Roth IRAs are not subject to the lifetime RMD rules. You can avoid the Roth 401(k)/403(b) lifetime RMD rules by rolling your eligible distribution over to a Roth IRA.
1If your distribution includes employer stock or other securities special tax rules may apply that can make taking a distribution more advantageous than making a rollover. Consult a tax professional.
Michael Chatterton, CRPC®
Vice President, Wealth Management
Consumers Financial Group
1501 E. Woodfield Rd
Schaumburg, IL 60173