One of the biggest decisions new retirees—or even those still in the workforce and moving to a new company—must make is what to do with the money in their employer sponsored retirement plan. Most spend much of their career making sure they are saving enough for retirement, but few consider how these funds will be managed once they decide to retire.
You will typically have several options: leave the funds in your employer plan, take a lump sum distribution or roll them over to an Individual Retirement Plan (IRA). The best approach ultimately depends on your current—and anticipated future—situation.
Understanding Your Employer’s Retirement Plan
An employer-sponsored retirement plan is a plan offered to employees to help them save for retirement. These plans, such as a 401(k), 403(b) or SIMPLE IRA, allow employees to contribute to a plan that offers beneficial tax treatment. Your contributions are generally yours.
Following the conclusion of your career or changing employers, it will be time to make some decisions regarding where you will house your retirement assets. Whether you are retiring, or starting a new job, there are generally three options that you may have with your retirement savings.
Some employers allow participants to remain in their plan, provided they meet certain requirements. This is good news because you retain the tax advantaged status, and it allows you time to decide what to do. However, because you are no longer an active employee, you cannot add any new money to the account. Additionally, you may have limited flexibility with investing the funds or limited timing for withdrawals. For example, you may have limited investment choices with your plan, or the plan may only offer annual withdrawals.
A second option is to take a lump-sum distribution, which is potentially subject to income tax and a 10% penalty (if you’re under age 59½). Depending on the dollar amount and type of contributions you made, this may result in a large taxable event. However, you would then be able to invest or use the funds as you wish.
A third option is to roll the funds to another retirement account. If you are changing employers, you may be able to move the funds directly to your new employer’s retirement plan. If you wish to have flexibility over accessing funds and expanded investment decisions, while preserving the tax advantage, a rollover to an IRA might be the right choice for you. Before deciding to do a rollover, it is important to understand the different type of rollovers, and how they work.
Direct Rollovers vs. Indirect Rollovers
There are two types of rollovers: direct and indirect. A direct rollover is paid directly to your IRA or new employer’s plan. The funds are never paid to you. An indirect (60-day) rollover is a payment made to you that you later roll over to an IRA. When you request a distribution from your employer’s retirement plan, you’ll receive a statement describing the tax rules applicable to your distributions and your rollover options. It is important to read that statement carefully.
How a Direct Rollover Works
Before you do a direct rollover, carefully review your existing plan’s distribution form. For a direct rollover, you can have funds transferred directly to your new employer’s plan or to an IRA. You may use an existing IRA or set up a new one to accept the rollover. Your plan administrator will then transfer the funds directly to your new employer plan, or to your IRA via check or wire transfer, or provide you with a check (payable to your IRA) to deposit into your account.
How an Indirect Rollover Works
An indirect rollover works similarly to a direct rollover, but with some key differences. If you choose to do an indirect rollover, the funds will be distributed to you, rather than your IRA. Your plan administrator will either issue a check in your name or make a wire transfer to your bank account. As with a direct rollover, you can use an existing IRA or set up a new one at a financial institution.
There are two major disadvantages to indirect rollovers. First, your plan is required to withhold 20% of the taxable portion of your payment for federal income taxes. You’ll get credit for that amount when you file your federal income tax return. If you want to roll over the entire distribution, you’ll have to come up with the 20% that was withheld to make the rollover whole. Second, you run the risk of missing the 60-day deadline, which would make your distribution taxable. On the plus side, you’ll have use of the funds for up to 60 days.
It is best not to commingle pre-tax and after-tax contributions in an IRA. This means if you made after-tax contributions to your existing Traditional IRA, you should probably not use that to accept a rollover from an employer’s plan that includes pre-tax contributions.
Why Should I Consider a Rollover?
It’s important to understand what a rollover is, and how it works. This naturally raises the question of why should you consider a rollover. There are multiple benefits that come with rolling over employer retirement plans, such as:
Deciding if a rollover is best for you will depend on factors unique to your situation. It is important to review your employer’s plan and compare the facts with the financial institution you are considering rolling your funds over to.
Other Considerations
Rolling over employer retirement plans also opens the door for more sophisticated retirement planning strategies. As stated previously, one of the biggest advantages to rolling over to an IRA is the autonomy you have with the funds and investment decisions. Understanding your employer’s plan’s rules can be no easy task. Additionally, when considering your estate plan, IRAs often offer more payout timing options, including the Qualified Charitable Distribution once you reach age 70½.
Keep in mind you generally cannot make more than one rollover from the same IRA within a one-year period. You also cannot make a rollover during this one-year period from the IRA to which the distribution was rolled over.
Conclusion
We tend to focus our retirement planning conversations around saving for retirement, deciding when we want to retire, and income needs during retirement. It is easy to overlook another key decision—how will I manage my retirement savings? For some, that may be staying in your former employer’s plan, or taking a lump sum distribution. But for those who wish to have more flexibility in access to funds or investment choices, a rollover may be the best option.
At Busey Wealth Management, our team can help you build a roadmap for retirement. To learn more about our services or find an advisor near you, visit busey.com/wealth-management.
This is not intended to provide legal, tax or accounting advice. Any statement contained in this communication concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties imposed on the relevant taxpayer. Clients should obtain their own independent tax advice based on their particular circumstances.
This material is provided for educational purposes only and should not be construed as investment advice or an offer or solicitation to buy or sell securities.
This presentation is for general information purposes only. It does not take into account the particular investment objectives, restrictions, tax and financial situation or other needs of any specific client.
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