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\What is a 401(k) Rollover?
A 401 K rollover is an excellent option for someone looking to get started on their retirement planning. It is the transfer of money from a current 401(k) to a personal retirement account. Rolling over to an individual retirement account (IRA) also has the potential added benefits of greater investment options, tax-deferred savings, and lower account fees.
How to Rollover a 401(k)?
The first step towards rolling over your 401(k) is deciding which type of account you’d like to open. Your two main choices are a traditional IRA and a Roth IRA. The main differences between them include: when you pay taxes on your rolled amount, fees paid during or throughout the rollover, and withdrawal availability. To determine which option is right for you, here is a small summary of each account type:
Choosing an IRA account to open
Choosing the right IRA account to rollover your 401(k) to will determine the taxes you pay on your rolled amount. It is essential to keep in mind their differences so that you can make a decision that best suits your financial plans.
When rolling over to a traditional IRA, your investment becomes tax deductible up to a certain amount. However, keep in mind that tax deferral no longer applies when it is time to withdraw the funds. As a result of required minimum distributions (RDMs), you must begin to withdraw at age 72, regardless of whether or not you are still working.
If you are currently in a high tax bracket, choosing a traditional IRA might be beneficial because it remains tax-free up until it is withdrawn.
The amount will be immediately regarded as taxable income when rolling over to a Roth IRA. However, all of your funds do become tax-free after five years of remaining with the Roth IRA and following its requirements. Additionally, Roth IRAs have no lifetime distribution requirements, meaning that you can leave the funds in the account indefinitely as they grow tax-free. The left-over funds can then be passed down to heirs, who must withdraw from the account within ten years following your death.
If you are in a modest tax bracket but have the potential to enter a higher tax bracket in the future, choosing a Roth IRA may be beneficial. This is because the current tax cost might be less than those expected for you in the upcoming years.
If your 401(k) is currently a Roth Account
If your 401(k) was already a Roth account, it can only be rolled over to a Roth IRA. However, rolling a Roth 401(k) to a Roth IRA means that you will not pay taxes on any rollover.
Direct vs. Indirect Rollover
For direct rollovers, money is transferred electronically from one account to another or deposited via check written by a plan administrator. For indirect rollovers, the funds are deposited to you rather than your IRA account. If you wish to have an indirect rollover, you must redeposit the funds into your chosen IRA. You have 60-days to conduct the re-deposit after receiving the funds.
Some people choose an indirect rollover when they want to take a 60-day loan from their retirement account. However, if you fail to meet the 60-day deadline, you will be subject to withholding taxes and other penalties. Most often, the direct rollover is recommended to avoid the fear of missed deadlines and their consequences.
Rolling over your 401(k) to an IRA account is an excellent option for savings and investment opportunities. However, it is crucial to understand the difference between IRA rollover services to ensure that your choice coincides with your current financial situation. Remaining conscious of your current and future tax bracket is crucial when deciding between a traditional IRA and a Roth IRA. It is also important that you understand the differences between direct vs. indirect deposit to avoid incurring fees or penalties at the expense of missed deadlines. Utilizing financial planners will help you weigh the risks and rewards associated with various types of rollovers. At Wright Choice Financial Group, we help clients allocate their 401(k) into retirement plans that complement their future financial goals. With the help of financial planning, you can be sure that you receive the most out of your 401(k).