To roll or not to roll?

Ed Slott & Company

What's the best way to handle your company retirement plan?

Posted February 28, 2010

By Ed Slott & Company

Cerulli Associates, a Boston based consulting firm estimates that in 2010, as the baby boomers move into retirement en masse, distributions from company retirement plans will reach approximately $446 billion. In most cases, retirees and job switchers are best off rolling their money to an IRA. The typical company plan offers employees and former employees only a handful of investment choices. But in an IRA you can put money into just about any investment you want, with only a few restrictions. Many individuals feel uncomfortable taking control over their finances. But if you intend to leave your money to your spouse and children, you could lose a large estate planning break; the chance for your heirs to stretch out payments over their lifetimes.

In an IRA, your beneficiaries can take out their required minimum distributions and allow the rest to grow tax-deferred. Most 401(k) and other company plans force heirs to take the assets soon after the account holder dies. Employers generally don't want to be married to the employee's family forever. Recent changes to the rules in this area now allow non-spouse beneficiaries to rollover plan assets to both inherited traditional and inherited Roth IRAs, but generally it must be done on a timely basis in order to guarantee the availability of stretch-out payments.

Another advantage the rollover option offers is that you can establish multiple IRAs, each with a different beneficiary, and align the investments towards the particular needs of the beneficiary. For instance, you could choose conservative investments for the IRA that you leave to your spouse, while opting for investments with longer time horizons for the IRA targeted for your children. There may be times when keeping the money in your 401(k) plan may be advantageous. If you're between age 55 and 59 ½ when you retire or separate from service, decide whether you need the money for living expenses before you make a move. Generally, if you're age 55 or older when separating from service, you can withdraw the money from the company plan without having to pay an early withdrawal penalty. If you move the money to an IRA, a 10% penalty for early wtihdrawal will linger until you're 59 ½.

Assuming you don't need the money to live on, the worst thing you can do is cash out. You'll lose the benefit of tax deferred growth as well as a big portion of your nest egg. And if you're younger than 55 when you take out the money, you'll pay a 10% early withdrawal penalty on the taxable amount. One exception: if you have appreciated company stock in your plan and you are taking a lump sum distribution, you may want to move it to a taxable account, as you or your heirs could benefit from a special rule that applies to the net unrealized appreciation built up over the years.

If you decide to do a rollover, set up an IRA and instruct your company plan administrator to directly transfer your balance to it. If you take the distribution yourself, your company is generally required to withhold 20% for federal income tax purposes, even if you plan to roll over the entire amount. There could also be state and local income tax withholding, depending upon your domicile. When you take the money yourself from your 401(k) plan to roll over to an IRA, you also face a 60-day deadline to get the job done. If you miss this, the taxable amount will be included in your income for the year of the distribution, plus you'll be subject to an early withdrawal penalty if under age 55 and lose any chance for continued tax-deferred growth. You avoid those worries with a direct transfer. Note: generally when you are age 70 ½ or older, your employer will first take out your required distribution for the year and send that to you in a separate check. Your required distribution is not eligible for rollover to an IRA and you cannot satisfy your plan required distribution with a distribution from your IRA.

Ed Slott and Company has been called "The Best" source for IRA advice by The Wall Street Journal, and "America's IRA Experts" by Mutual Funds Magazine. Ed is a widely recognized professional speaker and author. Get more IRA information from America's IRA Experts.