Rollover to an IRA

What to do with 401(k) af­ter leav­ing job

The Morning Call - - BUSINESS CYCLE - El­liot Raphael­son

Leav­ing a job can bring up com­pli­cated is­sues, and one of them is what to do with your 401(k) plan.

Some in this sit­u­a­tion are tempted to cash out. If you do this be­fore age 59 1/2, you will face in­come taxes and a 10% fed­eral penalty. It's an un­wise move un­less there are se­ri­ous ex­ten­u­at­ing cir­cum­stances.

Many em­ploy­ers al­low you to keep your 401(k) plan with the com­pany even af­ter you ter­mi­nate em­ploy­ment, as long you have a cer­tain amount in the plan. But leav­ing the ac­count there means you can no longer add to it or bor­row from it. An­other op­tion is to trans­fer the funds to a new 401(k) plan at a new em­ployer or to roll them over to an IRA ac­count.

Rollover to new 401(k)

If you have a choice be­tween mov­ing funds to a 401(k) and to an IRA, which is bet­ter?

If you roll over your 401(k) to an IRA, it is likely that you have more in­vest­ment op­tions. How­ever, the 401(k) may have some at­trac­tive in­vest­ment op­tions not avail­able with an IRA.

If you are still work­ing, some 401(k) plans al­low you to roll over some funds out of your 401(k) to an IRA and al­low you to con­tinue con­tribut­ing to your 401(k).

This is an op­tion you may want to con­sider if there are at­trac­tive op­tions in both. Many 401(k) plans of­fer a loan op­tion, which isn’t avail­able with an IRA.

You should only use this op­tion if you know you will be able to re­pay the loan when you leave your po­si­tion. If you do not re­pay the loan in full, the out­stand­ing bal­ance is con­sid­ered a dis­tri­bu­tion and is tax­able, and you would in­cur the 10% penalty if you haven't reached 59 1/2.

An­other fac­tor is cost. The re­cur­ring cost associated with the 401(k) may be lower than the an­nual costs associated with an IRA.

Make sure you do a cost com­par­i­son be­fore you make the de­ci­sion to trans­fer funds to an IRA.

If you choose to roll over your 401(k) bal­ance to an IRA, you have two op­tions: a di­rect or an indi­rect rollover. The best al­ter­na­tive is a di­rect trans­fer from the cus­to­dian of your 401(k) to the cus­to­dian of the IRA. Ad­van­tages of this method are that you can do an un­lim­ited num­ber of trans­fers in a year, and you avoid in­come tax li­a­bil­ity.

In an indi­rect rollover, you re­ceive the funds from the 401(k). You then have 60 days to trans­fer the money to an IRA cus­to­dian. This ap­proach has some dis­ad­van­tages. One is this op­tion is only avail­able once in any 12-month pe­riod. If you make the mis­take of rolling over funds to the IRA more than once in a 12-month pe­riod, the IRS will as­sume it is a with­drawal, and the amount with­drawn will be tax­able. And if you haven't reached 59 1/2, there also will be a 10% penalty.

The sec­ond dis­ad­van­tage is that if there is any de­lay, for any rea­son, and the money has not been trans­ferred dur­ing the 60-day pe­riod, the amount with­drawn will be tax­able (along with the 10% penalty if you haven't reached age 59 1/2).

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