Rolling Over 401(k)s

401(k)s Are All About Gaining Employer Contributions

What sets 401(k)s apart from other forms of retirement savings, including IRAs, is that in most cases your employer will be matching your contributions into a 401(k) plan. This is a big advantage and is the real reason why this type of retirement account is so popular.

When you can get your employer to throw in their money along with yours into a savings account, this provides employees with an instant and substantial return on their money. We generally need to put in quite a bit of time to receive such a return on our money, and have to take on significant risks along the way.

When we are working with an employer who will do this for us, even though it’s really our money that they are giving to us, putting it in a 401(k) for us instead of just giving us the money in extra wages, this is something we do not want to pass up.

When we look to compare the future value of money with its present value, what we could spend it on later versus now, there is a certain amount of time decay that is involved that will lower the value of money the further out we look. To some degree this is natural and sensible, although people do tend to discount future money too much than they should.

If we throw in the sort of contribution match that most people are eligible to receive from their employers though, this can really turn the tables and get people much more willing to do the right thing, to pay attention to their future and save enough for retirement. We generally should be saving more, and if we just receive this money in cash at payday, chances are we will spend at least some of this money, if not all of it.

While we are working for an employer who is making contributions on our behalf to our 401(k) accounts, this can become the only game in town as far as saving for retirement goes and at the very least should be seen as the primary vehicle for our retirement savings.

401(k) Rollovers When We Leave our Employer

When we end up leaving our employer though, either due to retirement or to find another job elsewhere, this will of course put an end to this arrangement and they will certainly not be contributing to a 401(k) for us when we are no longer employed there. This is where the concept of a 401(k) rollover comes in, which gives us the opportunity to move the money in this account elsewhere.

We have to make a decision as to what we’re going to do with this particular 401(k) account once we leave, where we can withdraw some or all of the money, leave it in the account at the old employer if permitted to do so, or roll the account over into either another 401(k) account at our new employer or into a different type of retirement account.

Depending on how long we’ve been with our employer, we may be able to claim ownership of the entire account balance, part of it, or only the amount that we contributed to it. This depends on the vesting rules of the account, which are set by the employer since the employer administers it.

We may for instance have to remain with the company and contribute to the account for 3 years in order to have the employer’s contribution vested, although these rules do vary and we have to check with the administrator of our 401(k) plan to learn how this will all work for us.

We can always withdraw part or all of our vested contributions in a 401(k) or any retirement plan, but there are often consequences, and we want to be very careful to time our withdrawals so that we are not penalized and the funds are allocated toward what they are supposed to be allocated for, as a means of income in retirement.

Even if we are leaving due to retirement, we still want to have the funds in our 401(k) tax sheltered, to avoid penalties and poorly timed taxation, as well as to see this money continue to grow tax sheltered. The longer we can keep our money tax sheltered the better, and there are some options for us to do so in this case.

Some people keep their money in the old employer’s 401(k) plan and we may indeed be able to do that, and we may have a number of residual 401(k) accounts at various previous employers if we change employers frequently. This doesn’t just add needless complexity to our retirement portfolio, there are no real benefits to keeping this money in its original account past the point where we’re receiving matching contributions.

If not for matching contributions, there really wouldn’t be a fundamental reason to contribute to a 401(k) over an IRA other than to gain access to the greater contribution limits of the 401(k). Since we’re not contributing to the account at the old employer anymore, our contributions going forward will either be to a new 401(k) at our new employer, or if we’re retired or working somewhere that does not offer this option, we will be contributing on our own to something else.

401(k)s are very limited as far as what we can do with them, and when we invest in one, the employer will have a lot of say as far as what our money goes into. We may not really care about this, but if we have the opportunity to move the money into something with more flexibility like an IRA, this can end up being a wise choice in the end even though we may not consider it to be particularly meaningful now.

We may also want to roll this over into our new 401(k) at the new job, and as long as the new 401(k) isn’t meaningfully inferior, this has the benefit of keeping all of our 401(k) money in the same place, which makes things easier to manage.

If we wish to become more active in managing our portfolios, then an IRA does present significant advantages, and if we can roll over an old 401(k) into a traditional IRA we can keep our money tax shielded while enjoying the much greater flexibility and risk management potential that IRAs offer.

We can still contribute to a new 401(k) of course, and we would want to do that if we have the opportunity for having our contributions matched by our new employer, while at the same time playing a greater role in directing our old account.

This is not something that many people tend to do or even wish to do, making their own investment decisions, but if we are up for this and learn enough about how to do this properly, this does provide additional opportunities to help ourselves and grow our portfolios.

Rolling Over 401(k) Accounts After Retirement

As a general rule, we don’t really want to roll over regular 401(k) accounts into Roth 401(k) ones, although we may want to set up both and contribute to both, as some people do. What happens in this case is that we contribute to the Roth side, and our employer may make a matching contribution to our regular 401(k), and this can provide a good balance between these two forms of 401(k) accounts.

If we roll over a regular 401(k) into a Roth one, at the very least, we need to declare the rollover amounts as income and be subject to paying full taxation on the amounts rolled over. This is not something you generally want to be doing while you are still working, as you’ll pay at least your current marginal tax rate and this may even bump you up to a higher tax bracket, where you’ll pay an even higher rate of tax on part of the rolled over amount.

Once we retire though, our income will be reduced by the amount we were making, so we now have some room to work with. We often will be in a lower tax bracket and will also have some room that we can use and stay within that bracket.

In this case, it makes sense first of all to get our money out of a 401(k), even money that is in a Roth 401(k), because even these accounts are subject to minimum distributions at 70 ½.

Ideally, where we want our money when we retire is in a Roth IRA, as soon as we can get it in there, as both traditional IRAs and regular 401(k) accounts derive a lot of their power from deferring taxes on contribution amounts. When you retire, you aren’t really contributing to your retirement account, so there’s no more deferring that.

You are forestalling paying taxes on money already in the accounts though, but your effective tax rate is set at this point, and if you are going to be moving to another bracket is not only known now but you are already there.

You therefore want to free this money up and pay tax on it at your current rate and then allow that to grow further in a Roth IRA. Roth 401(k)s are an option as well but keep in mind that a 401(k) is only superior when your employer is contributing to one for you, otherwise you should be in an IRA type account.

It’s not that you can just throw it all into a Roth IRA at retirement though, as we never want to bump up to the next tax bracket up, so this rolling over will take time, and perhaps quite a bit of time. As you transition here, you are going to want to take the money you need to spend out of the Roth IRA, because any more distributions from the 401(k) or a traditional IRA will incur higher taxes since we’ve maxed this out with the Roth IRA rollover.

When we reach 70 ½ and have to take prescribed withdrawals from our 401(k)s and our traditional IRA if we have money in that, we will need to account for these withdrawals in the amount we can roll over to our Roth IRA without incurring higher tax, but it is all a matter of simple math and people should be able to calculate all this for themselves.

We can do whatever we want with no implications with the money that has been rolled over to our Roth IRA, but we do need to keep it there until we need it and not withdraw from it just to put money in another savings vehicle.

If we have money in a Roth 401(k), we can just roll that over into the Roth IRA at retirement, without having to worry about any tax implications of this, which is one of the benefits of a Roth 401(k) over a regular 401(k).

With a little planning and a little diligence, we can distribute our retirement money to best benefit us once we reach the retirement stage, and being able to roll over accounts can not only help us but help make up for some mistakes that we may have made earlier in our careers.