An IRA rollover occurs when you leave a job or reach age 59 ½, and as a result you are entitled to “rollover” your previous employer’s 401k plan to an IRA.
There are many reasons to rollover a 401k to an IRA. One of them is that IRA offers significant tax savings and greater opportunity to compound your money tax-free.
This rollover option also gives you maximum control of your investments and flexibility of choice since you are not limited to the investment options provided by your employer. You have absolute control of which company to invest your money with and you can base your decision on the types of funds, fee and track record of the company. With a traditional 401k, you have no control over those things.
However, before you initiate the move, it is important that you’re aware of the IRA rollover rules so as to avoid negative tax implications when performing an IRA rollover.
60-day Rollover vs Direct Rollover
Whenever you rollover your 401k plan to IRA, you will be issued a check for 80% of the account value of your 401k account and will have 60 days to deposit the money into an IRA. This is sometimes known as the 60-day rollover rule. However, you will still be expected to deposit the full 100% of your 401k account balance into the IRA plan.
For instance if you are rolling over a $100,000 account into an IRA, you will be given a check for $80,000 and expected to deposit $100,000 into your IRA plan with your own $20,000 (which will be reimbursed later when you do your taxes).
If you’re late, the money will be treated as a ordinary income and taxed at your current ordinary income tax rate. Plus, if you did not reach age 59.5 when the distribution occurred, it will be deemed as a taxable distribution and you’ll face a 10% penalty on the withdrawal.
Optionally, if you’re going to transfer your 401k into an IRA, authorize for direct rollover via a trustee-to-trustee transfer to avoid 20% automatic withholding penalty. In a direct 401k rollover scenario, there will be no taxes incurred even if you rollover maximum funds.
For this reason, a direct 401k rollover is really the safest, easiest and most convenient way to move your retirement funds.
Rollover or Transfer?
If you are simply moving your IRA from one financial institution to another (and you do not need to use the funds), then you should consider using the transfer method, instead of a rollover.
A transfer is a tax-free non-reportable movement of assets between retirement plans, and can be done for an unlimited number of times during any period. A rollover, on the other hand, leaves room for errors such as missing the 60-day deadline.
Whether you’re looking for higher returns or more investment selection, a 401k rollover to IRA is indeed a great way to maximize your retirement dollars; as long as you’re aware of the IRS rules regarding the rollover to IRA and their potential tax consequences.
2010 Contribution Limits
The 401(k) contribution limit for is $16,500 for those under 50 years old. For anyone between the ages of 50 and 59 ½ years old you also have the option of contributing an additional $5,500 as a catch-up contribution.The IRA contribution limit for is $5,000 for those under 50 years old, with a $1,000 catch-up contribution option for those between 50 and 59 ½ years old.