By Richard Eisenberg, Next Avenue
In his classic tune “Roll Over Beethoven,” Chuck Berry famously belted: “Roll it over then move on up.” Well, if you’ve saved for years in a 401(k) plan, you’ll want to know how — or whether — to roll it over to move on up when you retire.
My “Friends Talk Money” podcast co-hosts Terry Savage, Pam Krueger and I just released an episode all about this, where Savage offered tips for 401(k) rollovers, which I’ll share below. You can listen to the episode wherever you get podcasts.
The advice seems especially needed. As Savage said on the podcast, your 401(k) is probably your biggest asset aside from your home, but the new “Retirement Outlook of the Workforce” survey from the Transamerica Center for Retirement Studies found that 62% of employed workers said “I do not know as much as I should about retirement investing.”
Difference Between an IRA and a 401(k)
Before I provide our podcast’s tips on 401(k) rollovers, a definition: A 401(k) rollover happens when you move money from your employer’s retirement plan into a financial services company’s Individual Retirement Account (IRA), typically within 60 days of leaving your employer.
Once you turn 72, you must start taking out money from a traditional IRA each year through what’s called a required minimum distribution, or RMD. There are no RMDs for Roth IRAs.
You don’t have to roll over your 401(k) money to an IRA when you leave your employer for retirement. You can instead keep the money where it is with your employer or cash out and take the money all at once.
“Every option has a different tax implication in a different set of considerations. So, it’s important to understand each of these before you make the decision,” Krueger said on “Friends Talk Money.” And, she added, “it’s so easy to get it wrong; the mechanics have to be done correctly or you will pay dearly.”
That’s why Krueger recommends getting help with the decision and the logistics from a trusted financial advisor. It’s also why Savage recommends talking with your HR department about six months before you retire to understand your employer’s rollover rules and start making your plans.
You May Stay in a 401(k)
As I noted on the podcast, you may be perfectly happy leaving your 401(k) money where it is when you retire — what Krueger called “not leaving the comfort zone of the mothership of the 401(k) you’ve been in.” Maybe you like the plan’s investment choices and the fees for the plan are pretty low.
David Blanchett, of the investment advisory firm Morningstar
Also, an IRA’s fees may be higher than what you’ve been paying with your 401(k).
But rolling the 401(k) to an IRA at a financial services firm typically opens up a wider variety of investment choices than what your 401(k) offered.
If you decide to roll over your 401(k), you have two choices: a “direct” rollover — where the money goes straight from your employer’s plan into the IRA you’ve set up — or an “indirect” rollover — where you withdraw the money from the plan and then give it to the IRA provider yourself.
Rollover Dos and Don’ts
This leads to Savage’s Tip No. 1: If you’ll be making a 401(k) rollover, never take the money yourself. Always do a direct rollover, not an indirect one.
“Do not let your plan custodian send you a check,” said Savage. If you do, she noted, you’ll owe taxes and will pay a tax penalty if you’re under 59½.
Just understand — and I say this from personal experience — that arranging a 401(k) rollover can be something of a hassle with a fair amount of paperwork. Ever tried to change banks? It’s something like that.
Tip No. 2: Find a low-cost, reputable financial services firm to hold your 401(k) rollover money. You don’t need to have a specific broker or advisor there, Savage explained.
Tip No. 3: Ask for an IRA rollover specialist at this company. Savage said that when you call to speak with the person, have in front of you your 401(k) account number and all your account information from the plan, which you can find on your latest 401(k) statement.
Advice Is Available, For a Fee
When you’re ready to roll over the money, Savage said, you might tell the specialist to put it all into a supersafe money-market account or do this online. “The interest is low [on a money-market account], but you won’t lose a penny,” she noted.
Taxes on the sales of the investments you had in the 401(k) will be deferred until you start making withdrawals unless you’re setting up a Roth IRA rollover.
Once you’ve made the transfer from your employer’s plan to an IRA with the financial firm, you can take time to decide how to invest the money.
Many financial firms let you work with an advisor there to help manage your IRA for you, for an annual fee of typically around 0.30% to 0.50% of the money.
Some firms also choose and manage your rollover IRA investments for you through digital accounts in their proprietary funds, often for no fee or a fee of under 0.35% a year.