5 Good Reasons to Move Your 401(k) or 403(b) When You Retire:
- Most 401(k)s, 403(b)s and other company plans have limited investment options. They may offer 50 different mutual funds and other investment vehicles, but most of the options are subject to market fluctuations. If we learned anything in 2008 and early 2009, it was that what the market gives gradually can be taken away quickly with little to no warning. Many company plans lost as much as 40 % in 2008 alone. Those individuals who chose to play it safe and moved their 401(k) money into bond funds or funds invested in CDs and other short-term investments were rewarded with little or no growth, while inflation and management fees ate away at their principal. Moving the 401(k) or 403(b) to an IRA will offer the owner unlimited investment options. Some of these options can guarantee the principal, offer a competitive rate of return, and generate an income that cannot be outlived.
- Plan guidelines can restrict the owner’s access to their money. The plan document is essentially the 401(k) rule book. If it is not in the book, you can’t do it! With savings down and unemployment up, you never know when you may need access to your retirement accounts. IRAs offer greater flexibility, allowing the owners to make their own rules if they are willing to pay the tax on the distributions.
- Direct rollovers avoid the 20% mandatory withhold-ing. It’s critical that the funds are moved as a trustee-to-trustee transfer. If a check is written to the 401(k) owner, you can count on the custodian withholding 20% for the IRS. I have worked with several advisors who have encountered this problem, and they are still battling with the IRS to get the 20% withholding back where it belongs.
- 401(k) and 403(b) plans have limited distribution flexibility for the children and grandchildren, who are likely to inherit when both the owner and spouse are gone. In 2002, when the “Stretch Option” was born, children and grandchildren of IRA owners were given new valuable distribution options. They now have the ability to spread the inherited IRA distributions over their individual life expectancies, according to Appendix C, Table 1 of IRS Publication 590. This means they are no longer forced into rapid distribution, causing rapid taxation. Unfortunately most 401(k) plan administrators didn’t get on board with this valuable income planning tool and, in many cases, they are forcing these non-spousal beneficiaries to take full taxable distribution in just five years. Under the Worker, Retiree and Employer Recovery Act of 2008 (HR 7327), beginning January 1, 2010, all employer plans were required to allow non-spousal beneficiaries to do direct rollovers to inherited IRAs. Rolling the inherited company plan to an IRA allows these beneficiaries to take control of their inheritance and opens up unlimited investment options and greater income flexibility.
- Many 401(k) and 403(b) plans do not allow the Roth IRA Conversion. New legislation, The Small Business Jobs Act of 2010, now allows 401(k) participants to roll their traditional 401(k) to a Roth 401(k); however, until their plan documents are amended, some plans will not permit this maneuver. Beginning in 2010, IRA owners with adjusted gross incomes over $100,000 could, for the first time, convert their traditional IRAs to the Roth IRA. After the conversion tax is paid, the new Roth will grow income tax free, and distributions after the five-year holding period will also be income tax free. The Pension Protection Act simplified Roth conversions from 401(k)s and other company sponsored plans. Beginning in 2008, owners could convert company sponsored plans directly to a Roth IRA. They no longer needed to convert to a tra-ditional IRA before converting to a Roth IRA.
The good news is that you may not have to wait until you retire to move your 401(k), 403(b), and TSP plans to an IRA.
Approximately 70% of 401(k) plans allow for an In- Service Transfer. That means there is a 70% chance you can move the 401(k) to an IRA while you are still working, making contributions, and enjoying company matching funds. Most of the plans that allow the transfer require the employee to be at least age 59½. You will need to check with your plan administrator or your HR department to see whether your plan allows for the In-Service Transfer. You should also make sure that there is no blackout period. A blackout period is a period of time after making the transfer that you may not be able to continue to make contributions or receive company-matching funds.
There is a special gold nugget in the tax code for those who are employees or retired employees of non-profit organizations, such as hospitals, museums, public foundations, churches, research organizations, or public educational systems, and who made contributions to their 403(b) or Tax-Sheltered Annuity (TSA) plans.
Most 403(b) plans and TSAs allow the owners to switch to an IRA if they are over 591/2, have a break in service, or transfer to a new school district. In our current economic environment, many educators are being forced into early retirement. This is another opportunity to move their restrictive 403(b) plans and other teachers’ retirement plans to a more flexible IRA.
If you currently have a 401(k), 403(b) or other company-sponsored plan, you should examine all of your options to decide whether rolling the plan to the more flexible IRA is consistent with your overall retirement goals.
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