Should I Roll My 401k into an IRA?

401k to a IRAWhen you separate your service with your employer, you have 4 options for managing your 401k.

1)      Leave the money in the 401k

2)      Roll it to an IRA

3)      Cash it out and pay income taxes on the entire amount (plus a 10% penalty if you are below age 59 ½)

4)      Roll it into your new employers 401k

The option best for you depends on a couple of key questions:

When will you need the money?

You are allowed to withdraw funds from your 401k at age 55 without the 10% penalty. But if you were to move it to an IRA, you have to wait until age 59 ½ to avoid the penalty.  If you are planning for an early retirement let’s say at age 55, the 401k plan may allow you to leave your funds with them and turn on an income stream to pay you a set amount of money each month.  Some companies don’t allow you to change that election until you roll over your 401k to an IRA.  So for example, if you need $3000 per month for the first 5 years of retirement until reaching age 59 ½ which is a total of $180,000 you can leave the $180,000 in the plan and rollover the amount above $180,000 to an IRA and your 401k company can deposit $3000 to your bank account every month while avoiding the 10% early withdrawal penalty.

Do you have company stock in your 401k?

Before deciding to roll it over you should talk to a financial advisor to see if you should take advantage of Net Unrealized Appreciation or NUA.  NUA is a very complicated animal.  But in short, it is a way to substantially reduce future taxation of the money that is invested in company stock.  So just make sure you have explored NUA before rolling over your 401k because it is a use it or lose it deal.

Do you have money in the plan that you’ve already paid taxes on?

Before making any decisions, call your plan manager and find out how much money you have in after tax money.  You will want to keep track of when this money is withdrawn because you don’t want to pay taxes on it again.

I would almost never suggest the option of cashing out your 401k in its entirety.  That would stick you with a very high tax bill for the year.  And just make sure that whatever funds you do plan to rollover, you understand the fees involved and the investment options available.

To learn more about Deanna LaRue, view her Paladin Registry profile.

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