Should you rollover your 401k?

Should you rollover your 401k?

According to the Investment Company Institute, 401K plan assets reached $4.8 trillion dollars at the end of the first quarter in 2016. That’s nearly 20% of total retirement assets in America (which was at $24.1 trillion).

For 401K plan holders heading into retirement, changing jobs, or leaving a company, a big question looms: what should be done with this type of retirement savings account? Essentially, investors have to choose whether or not to roll the money over into a new account.

Options for rolling the 401K over include putting the cash into a self-directed IRA or transferring it to a new employer’s 401K plan. If workers decide against a rollover, the other options are to leave the account alone or cash out. Before making a decision, investors should look at the pros and cons and choose based on their unique situation.

Rollover Options and Advantages

There are significant advantages to rolling the 401K over to a new employer’s plan or IRA. Most investment professionals advise choosing an IRA, but it’s important for workers to also examine the quality of the new company’s 401K plan (if going to another job).

Pros of the Rollover into a Traditional IRA

Dr. Don Taylor, a retirement advisor and contributor at Bankrate, says that the rollover to a traditional individual retirement account from a former company’s 401K plan can provide “wider investment choices and potentially reduced annual fees and other expenses.” This flexibility makes the IRA an attractive selection, as investors can choose among mutual funds, stocks, bonds, and exchange-traded funds.

Like with a traditional 401K employer plan, money can continue to grow tax-deferred in a traditional IRA. That way, investors won’t have to worry about capital gains and dividend taxes each year.

This also allows workers to shop for plans with lower fees, and, if desired, select an IRA with more access to investing tools and management guidance. The IRA can also be withdrawn without penalty for specific purposes, like college tuition or a first-time home purchase (up to $10,000).

Pros of the Rollover into a Roth IRA

Unlike traditional IRAs, Roth IRA contributions are made after income is taxed—with the benefit that earnings are not taxed when withdrawn later. Because contributions are made after income taxation, investors have the ability to withdraw those contributions (not earnings) from the account without fees.

The Roth IRA does not have minimum required distributions after reaching age 70½, unlike 401Ks and Traditional IRAs. This makes it a potentially lucrative investment vehicle into old age and a good option for those looking to set up future generations.

Since the Roth IRA rollover requires a tax payment before transfer, Dr. Don Taylor attests that a Roth IRA rollover makes sense only if investors can come up with the tax fees from a source other than the 401K funds and “expect to be in a lower tax bracket now than when (they) start tapping retirement funds.” This makes paying the taxes now financially beneficial in the long run.

Pros of the Rollover into the New Employer’s 401K Plan

Most employers offer new employees the chance to roll over their old company’s plan. Getting all retirement plans into one place can make saving much more convenient and cheaper.

Investors should compare fees between the two company’s plans, and only roll over their old 401K’s cash if the new employer’s plan has lower fees and/or better investment options. The new company’s plan may even have lower fees than IRA accounts do.

For those that do choose to transfer to the new company’s fund, understand those earnings will continue to grow tax-deferred, and while those funds can be withdrawn after 59½ years old without penalty, workers may have the option to delay required minimum distributions (RMDs) beyond 70½ years old (if still employed at that company).

Traditional benefits of the old 401K still apply at the new company too. Investors are given more protection under federal law, as 401K assets are better protected from claims from creditors than IRA assets are. Many 401K plans provide investors the benefit of being able to borrow against the plan as well.

Options for Those Choosing Against the Rollover

While rolling the account over is traditionally the best choice, everyone’s personal situation is different. In some circumstances, one of the following two options may be the most ideal—or necessary—choice.

Leave the 401K Alone

The first and most common choice is simply to leave the 401K account with the old employer and let earnings continue to rise tax-free. For investors that like their current plan, aren’t paying a lot in fees, and are happy with its performance, this may be the best—and easiest—choice. Prior to doing this, do compare fee charges with other fund options, like the new business’ 401K plan and traditional and Roth IRAs.

In addition to having the benefits mentioned above for 401K plans, there is also a specific benefit for not touching the 401K. For those that leave their employer between the ages of 55 and 59½, they can enjoy penalty-free withdrawals before reaching 59½ (the typical starting withdrawal age).

Before doing this, ex-employees should check to see if their employers allow the money to stay in their old account. Most companies require at least a balance of $5,000

Cashout

A final choice is the cashout. Most investors don’t suggest this route, as paying taxes on the withdrawal alone could easily cut into 35% of the total amount (depending on the tax bracket). A withdrawal penalty of 10% would also be assessed if younger than 59½.

Additionally, savings would no longer grow tax-deferred, which means investors robbing their future selves. For example, take the case of a worker making $75,000 per year who has a traditional 401K with $50,000 in assets. This worker decides to withdraw it all after quitting the company. In this case, 25% of that amount would be taxed and a 10% penalty would be implemented, leaving the worker with 35% less, or just $32,500. If this money was simply just left in the 401K and continued to grow at a decent rate for one or two decades, this easily turns into a six-figure mistake.

The cash-out option is mostly seen as a last resort for those experiencing a legit financial emergency and can’t access cash from other sources, such as lenders, savings accounts, and family. Only do it if absolutely necessary. Nearly every time, borrowing from other sources makes more financial sense than cashing out retirement savings.

Making the Best Decision with the 401K

While the traditional IRA is commonly seen as the best rollover option for 401K plans with an old employer, everyone’s personal situation is different. Ideally, workers should always research and choose retirement savings plans with low fees and high returns. They should make choices that set them up for long-term financial success.

Thus, it’s advised to also analyze the financial advantages and disadvantages of rolling over to the Roth IRA, transferring to another company’s 401K plan, and leaving the money with the old 401K. Once workers have a clear picture of what makes the most financial sense, they can go through with the decision—and watch their nest egg grow to its highest potential.

Would you pass this three question retirement planning quiz?

Would you pass this three question retirement planning quiz?

Reports claim that 10,000 Baby Boomers are retiring every day. But many of them are retiring into a standard of life that is significantly less ideal than they imagined. You don’t want that for you.

Don’t worry. If you’re smart, retirement will be a breeze. It just boils down to asking the right questions. 

Those questions are:

  1. Can you afford it?
  2. Where should you retire?
  3. How do you maximize social security benefits?

Retiring broke

One of the biggest fears people have about retirement is that they’ll retire broke. The problem with this way of thinking is that retirement isn’t an event. Rather, it’s a process that starts even before you reach your prime working years.

Unfortunately, more than half of Americans go into retirement broke, with nothing to show for the 35+ years they’ve been working. According to a GoBankingRates research, there is a significant chunk of the population that has less than $10,000 saved for retirement. Worse, many don’t have any savings at all.

A survey by Bank of America Merrill Lynch revealed that about 81% of Americans don’t even know how much they need to save for retirement.

Below are 3 questions to help you be more proactive in how you handle the retirement process.

1. “Can you afford it?”

The current economic environment has led to a rise in the number of people who are ready to retire but can’t. The common phenomenon is a hybrid; people are in retirement but they’re still working.

So, how much money do you need to avoid this situation?

To be able to answer that question, it boils down to one simple idea: your expenses need to be less than your income. There’s more to it, but that’s the basis.

Being retired means living on a fixed income without a possibility of salary increment. Also, your expenses won’t always be fixed: healthcare goes up, taxes fluctuate, and things cost more in general over time. There are assumptions you’ll need to make when saving up.

As a guideline, many financial planners advise you to start saving up to 15% of your income while you’re still in your 20s. If you want to know the exact amount, professionals estimate that you should have at least 10 times your last full-year income by retirement. Thus, if you make $100,000 in your last year of work, you’ll need at least $1,000,000. Use this online calculator to estimate how much you need.

To increase your income, start saving and investing as early as possible. Take advantage of accounts such as Roth 401(k)s and Roth IRAs.

2. “Where should you retire?”

Another thing most people overlook is the impact where they live has on their income. For instance, did you know that 13 states tax Social Security benefits while 37 don’t? Of the 13, 9 exempt tax up to a certain limit. The remaining 4 (Minnesota, Vermont, North Dakota and West Virginia) tax your benefits, no exemption.

Also, different states have different laws regarding estate and inheritance taxes. Some states have estate tax while others have inheritance tax. Yet, New Jersey and Maryland have both taxes.

You may also want to understand the different property tax rates across states. This will be crucial in helping you understand how you spend your money once you retire.

Bottom line: Understand the tax implications of your retirement state or city to save yourself from unnecessary surprises.

3. “Do you know how to maximize your Social Security benefits?”

A MassMutual quiz aimed at testing how much Americans know about the Social Security retirement benefits asked over 1,500 adults 10 basic Social Security questions and only one answered all correctly. Only 28% got seven or more questions right––this was the passing grade.

Will you be part of the many that retire without understanding how they can maximize their Social Security Benefits?

Although Social Security is designed to cover the disabled and survivors of deceased workers, is primary purpose is to assist retired workers with their monthly expenses and without it, most retirees would probably be in big trouble. According to a Gallup report, more than half of the retirees says Social Security is a major source of income.

While the Social Security benefits at Full Retirement Age (FRA) are capped at $2,687 a month in 2017, there are a number of ways that a retiree could use Social Security to boost benefits.

For instance, there’s a “Social Security secret” you can use to get an additional $15,978 each year. Retirees can influence the amount they are paid in Social Security by choosing when (what age) to claim their benefits. At FRA, a retiree is entitled to 100% of their benefits. Retiring before reaching the FRA reduces the monthly benefit. However, holding off filing for the benefits by a year increases your benefit by about 8%. This method works so well that 23% of retirees regret not waiting longer before filing.

Depending on how “lavish” you plan your retirement being, you might need a little more or less money. When in doubt, always opt for the higher amount. You never want to be surprised by post-retirement costs, and you always want to be ready.