When you leave your job for any reason, you usually have four choices regarding the retirement savings you hold in connection to that job:
- Do nothing: Though some employers will not allow you to maintain your retirement account with them, many will allow you to keep it. If your employer will allow you to keep your account in force, you can continue to manage the investments within the account without any change or interruption. You cannot make additional contributions, however.
- Transfer to a new plan: If you’re changing jobs and your new employer offers a retirement plan, you may be able to move your assets into the new plan.
- Withdraw your assets as cash: If you sell and withdraw your assets, the regular withdrawal rules and penalties will apply. If you choose this option, your employer will also be required to withhold 20% of your account balance for tax purposes.
- Roll over your assets to a Rollover IRA. This is probably your best choice since it allows you to maintain the maximum amount of control over your own account AND continue to make contributions.
What is a Rollover IRA?
A Rollover IRA is a type of retirement account into which you can transfer assets from an employer-sponsored retirement plan after you leave your job. Banks, some insurance companies, and other financial services firms offer Rollover IRAs but the easiest to use are the online brokerages like Scottrade, E*Trade, TradeKing, Charles Schwab’s optionsXpress and tradeMONSTER. They come in two varieties:
- Traditional Rollover IRAs: For participants rolling over assets from tax-deferred retirement accounts, such as regular 401(k)s, 403(b)s, or 457(b)s
- Roth Rollover IRAs: For participants rolling over assets from tax-free accounts, such as Roth 401(k)s
Though it’s possible to roll over a pretax retirement plan to a tax-free Rollover Roth IRA, doing so is a taxable event, which means you’ll owe taxes on any gains in the account at the time of the rollover. Due to these negative tax consequences, it’s best to avoid doing this type of rollover.
You may be able to do a “two step” rollover by moving your 401(k) into a traditional IRA and then converting your traditional IRA to a Roth IRA. You may be able to complete this process in multiple steps to avoid any tax implications so check with a qualified financial advisor.
Should You Use a Rollover IRA?
In most cases, it makes sense to use a Rollover IRA unless:
- You’re satisfied with your existing plan and your employer will let you keep it there for at least several years after you leave
- You find your current employer’s retirement plan satisfactory and you want to roll over the assets to that plan instead
Unless one of these two situations applies to you, rolling over your plan assets into a Rollover IRA is usually a good idea. A Rollover IRA can help you:
- Avoid taxes and penalties: With a Rollover IRA, you avoid the taxes and penalties you’d pay if you transferred or withdrew money from your account.
- Keep growing your money: Using a Rollover IRA is a seamless way to keep your retirement investments growing without interruption.
- Expand your investment options: Rollover IRAs usually allow you to invest in virtually any type of investment, from individual stocks to bonds to mutual funds, depending on the financial firm you choose. Any constraints imposed by your employer-sponsored plan will no longer apply.
How to Roll Over Your Existing Retirement Plan Account into a Rollover IRA
To set up a Rollover IRA, you need to take action before you leave your job. To do so, you must:
1. Set up a Rollover IRA account
Contact the financial services firm you intend to work with and ask about the forms and other documentation required to open a Rollover IRA. You’ll usually have to provide a copy of your most recent retirement plan statement. In most cases, the firm will offer to contact your employer to handle the rest of the rollover process for you. Even if they do, you should still follow the remaining steps.
2. Tell your current employer
Tell your employer that you intend to roll over your retirement plan. Give them the contact information of the firm where your Rollover IRA will reside, and tell them you want to perform a direct rollover rather than have them cut you a check for the balance of your account. If they insist on cutting you a check, make sure the check is made payable to your Rollover IRA provider—not to you.
3. If your employer issues a check payable to you (bad idea!)
Your employer will be required to withhold 20% of your balance, and you may be required to pay a 10% penalty when you do the rollover. To prevent this, ask your employer to cancel the check and make it payable to your Rollover IRA provider. If they refuse, you can avoid a 10% penalty as long as you use the check made payable to you within 60 days to fund a Rollover IRA. However, your employer will have already withheld 20% of your account balance for taxes. Usually, the only way to get that money back is to add that amount to your Rollover IRA with your own money for the time being, and then request a refund for those funds when you file your tax return. To qualify for this refund, you must roll over 100% of your account balance.
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