Five must-knows for 401(k) to IRA rollovers

Thinking about a rollover from your old 401(k) or other savings plan to an Individual Retirement Account (IRA)? It’s a painless move (we swear) that could pay off in the long run.

Desk pictures boxed up? Check. Two hundred soy sauce packets tossed? Check. Anything else before you walk out that office door a final time? Oh, yeah—what about your 401(k)?

Job changes can complicate keeping track of employer-sponsored qualified retirement plans (QRP), of which 401(k)s are the most common. What about when you retire and leave the workforce for good? What should you do with your 401(k) then?

This process involves IRS regulations, so it’s understandable if you have many questions. Typically, once your employment ends, you have four options for your company-sponsored retirement assets:

1. Leave all or part of the money in your former employer’s plan, if permitted 2. Roll the funds into a new employer’s plan (assuming you continue to work), if available and rollovers are permitted 3. Roll over the assets into an Individual Retirement Account 4. Cash out the balance, coughing up the applicable taxes and penalties (which depend on your age and circumstances)

There are many considerations to keep in mind with each, such as withdrawal options, investment choices, services, fees, tax implications and your unique financial needs and plans for retirement. Let’s tackle five of the biggest questions and concerns to help get you "rolling."

A rollover to an IRA is simply another opportunity for potential tax-deferred investment growth, usually with a bigger menu of market choices and greater flexibility than workplace QRPs. It is important to consider and compare investment-related expenses for your employer plan, a new employer plan, as well as for a new IRA. This comparison could include plan administrative fees, service fees, sales loads and commissions on the underlying investments that the plan or the IRA may incur. Importantly, IRAs, including Roth IRAs, offer compelling tax advantages over 401(k)s and other retirement plans.

What’s more, rolling your 401(k) from previous employers keeps you in control of your retirement plan. With your accounts in one place, you can get a better look at your overall financial picture and see if your assets are properly diversified or if they need to be reallocated. Plus, maintaining fewer accounts may help you cut some maintenance fees.

IRA rollovers are not all-or-nothing. You can use an IRA rollover to move just a portion of your funds from one IRA to another or to roll over part of a QRP to an IRA. Although you can opt for a rollover at any age, there are a couple of age targets to keep in mind.

You can begin taking IRA distributions after turning age 59½. That differs from 401(k)s, which you can tap beginning at 55. If you need that added age flexibility, you may consider leaving some funds in a 401(k). Now, whether your funds are in a 401(k), a rollover IRA, or a from-scratch traditional IRA, you have to start distributing and paying taxes on the overall total when you’re 70½. That’s what’s known as a required minimum distribution, or RMD, and we get into this in greater detail below.

When rolling funds from an employer-sponsored plan to your IRA, you can avoid mandatory tax withholding by requesting a direct rollover. In this case, although the check may be mailed to you, it will be made payable directly to your new trustee or custodian. If, on the other hand, the assets are distributed in your name, you have 60 days to re-deposit them in a plan or face taxes and other penalties.

Another myth that needs debunking is the so-called 365-day rule. This rule generates some confusion, as overly simplified IRA definitions say that transactions are limited to once a year. But this yearly restriction does not apply to direct rollovers from QRPs, such as 401(k)s, or to direct transfers of IRAs, where the assets are moved from one IRA account to another IRA account. The IRS 590 rule is intended to prevent multiple rollovers within the one-year period from the same IRA.

For example, if you hold two outside IRAs and have opened a third IRA at TD Ameritrade, both outside IRAs can be rolled over into the TD Ameritrade IRA within the one-year time frame with no penalty. However, if you do a partial rollover from the first IRA to the third IRA, you cannot then do another rollover from that first IRA again. Note that the one-year period starts on the date of distribution, not on the date you roll it into an IRA.

What’s more, you can always roll over to a traditional IRA and then convert to a Roth whenever you want. That eliminates the worry about the once-per-year rollover rule.

You do defer taxes over the life of your IRA. But at a certain point Uncle Sam wants his cut. All IRAs are seen as one total dollar amount in the eyes of the IRS.

Required minimum distribution, or RMD, kicks in at age 70½. The amount you must withdraw is calculated annually (don’t forget to rework the numbers each year) based on a combination of life expectancy and account value as of December 31 the year before this age milestone. Don’t forget this rule—the penalty fee is a steep 50% of your RMD.

An important item to note: RMDs are not eligible for rollovers. If you’re still working at 70½, you may not be required to take RMDs from your current employer’s plan, such as a 401(k). This may be advantageous for those who plan to work into their 70s.

It’s important to the IRS (and to you) to separate your before-tax and after-tax withholding 401(k) contributions. If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.

You might opt to convert these contributions directly over to a Roth IRA, in most cases with no tax consequences. Commingled IRA assets might require you to file an IRS form 8606 with your annual tax return to protect what should be tax-free withdrawals of those contributions.

When you left a job for whatever reason, “liquidating” (selling) your 401(k) assets used to be the usual tack—say goodbye to your soon-to-be-former coworkers, then wait for a check to arrive in your mailbox. You’d then reinvest that money in your new company’s retirement plan.

But so-called in-kind, or trustee-to-trustee, transfers are becoming more common. In many cases, you can shift assets from one custodian to another, without selling anything, in what’s known as a "transfer-in-kind." Your existing stocks, mutual funds, and even exchange-traded funds (ETFs) may be able to be moved to your new account.

If your old 401(k) includes company stock, you might explore the advantages of net unrealized appreciation (NUA). This allows a participant to withdraw the company stock “in-kind.” The cost basis of the stock will be recognized as income in the year of the withdrawal, but NUA can substantially reduce future taxation (when required distributions force their liquidation) and ensure the most optimal taxation of these assets.

More and more 401(k) providers are allowing in-kind transfers. But ask the appropriate expert first to make sure you understand how it works.

If you plan to roll over, transfer, or cash out, call your 401(k) plan administrator to request the distribution. Sometimes you have to fill out a distribution form, but increasingly, 401(k) providers are accepting verbal instruction for rollovers.

Remember, using the IRS website, or better yet, contacting your tax professional, is always advised. Research is empowering in investing decisions, and rollovers are certainly no exception. Yet, perhaps the most important truth to uncover with rollovers is that you don’t have to make the move alone.