IRA Rollover

Author: Steven posted in Retirement planning tagged with 401(k), Roth IRA, Traditional IRA

What is an IRA Rollover?

An IRA rollover occurs when you transfer funds between two different types of retirement plans. IRA rollovers most commonly occur when the owner of a 401(k) or 403(b) account decides to transfer their investment capital to a traditional IRA or Roth IRA. This usually occurs either because the account owner changes jobs or because the plan was terminated by the employer (which is possible because retirement plans are not mandatory by law). Other reasons for IRA rollovers include investors who feel their retirement plan is too restrictive, has excessive expenses or is not aligned with their desired asset allocation. Many employers have rules that restrict your ability to conduct an IRA rollover while you still work for the company (called an in­-service withdrawal) so check with them to see if this is allowed before leaving the company.

IRA rollovers can also take place from an IRA to another IRA. When you rollover funds from one IRA to another IRA, you cannot make another IRA rollover from the same IRA within the next 12 months. It is also very important that the IRA rollover is completed within 60 days from receiving the funds. If not, you will have to pay income tax on the amount received and if you are under age 59 ½ a 10% early withdrawal penalty could also apply. When transferring funds from one IRA to another IRA, rather than requesting a rollover which involves both the 1­year limit rule and the 60­ day completion rule, you should request a direct transfer where you never receive the funds . In this case you are simply transferring funds directly between two accounts of the same type and there is no distribution to you. Also known as custodial transfer, it simply involves a direct transfer from one financial institution another financial institution and can be done as many times as you wish without any penalties.

IRA rollover benefits

IRA rollovers can provide a significant benefit to the investor because you continue to enjoy the tax advantage of a retirement account and can invest in stocks, bonds and other vehicles that best match your investment goal. Transferring funds from a 401(k) account to an IRA continues to provide tax shelter benefits while providing you with the flexibility of choosing the financial instruments (stocks, bonds, mutual funds) that you prefer to invest in since the plan is no longer controlled by your employer. When you invest in your company 401(k) plan your employer decides what your investment choices will be. IRA rollovers can also potentially reduce your investing expenses as many employer plans include relatively expensive investment options.

IRA rollover process

The mechanics of an IRA rollover are fairly straight forward. First of all, if you do not already have an IRA, you can open one with the financial institution of your choice. Then you inform your IRA provider that you would like to rollover your 401k funds to them. This can usually be done by filling out the required online form of the IRA provider. In some cases you will need to use the form provided by your 401(k) provider. Once this is done, it will take from several days to several weeks for the rollover transaction to be completed and your funds transferred from the 401(k) account into your new rollover IRA. Once this transfer has been completed you must decide how to invest the funds in your new IRA account in accordance with your asset allocation plan which should be driven by your financial goals, the time remaining to achieve them and your risk tolerance.

Mistakes to avoid

Some people commit the mistake of cashing out their 401(k) when they leave their job but this should be avoided unless you have an urgent need for the money. You shouldn’t cash out your 401(k) funds because you will end up paying income taxes on the amount you cash out and if you are not at least age 59 ½ you will also end up paying an early withdrawal penalty of 10%.

If you are not knowledgeable on this subject we advise that you get in touch with a professional financial advisor because mistakes in this area can be very expensive.

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