“Should I roll my 401(k) into an IRA, when I change jobs? The answer is usually, ‘It depends.’”
Retiring early, before age 59½? Instead of rolling your 401(k) into an IRA when you change jobs, you might consider rolling your plan over to your current employer's 401(k), rather than your own individual plan.
The reason? Rolling over your 401(k) to an IRA, can limit your withdrawal options in retirement, according to Forbes’s recent article, “Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”
There’s a 10% penalty to withdraw funds from your traditional IRA before 59½, unless you qualify for an exception. However, many people don't know that the IRS lets employees who retire or otherwise leave a company at age 55 or older, to withdraw from their employer's plan without a penalty. Therefore, if you retire at age 55 and roll over your 401(k) to an IRA, you'll have to wait 4½ years longer to withdraw your funds without a penalty.
At any age, there will be income taxes to pay on withdrawals. If you have a traditional 401(k), you got a tax break when you invested. Your funds then grew tax-deferred all those years. The IRS now wants to tax your money. When you withdraw from your traditional 401(k), your funds will be taxed at ordinary income tax rates.
There are also some side benefits to staying with a 401(k), instead of opening up a rollover IRA. First, it simplifies your investments. If you roll your 401(k) to your current firm when you switch jobs, you know exactly what your funds are invested in and can check the balance all in one place. It could also protect you from legal judgments. Keeping retirement funds in a company plan, instead of an IRA, will keep it safe.
You should discuss your asset protection strategy with your estate planning attorney.
Remember, not everyone qualifies to invest in a Roth. However, it is possible to contribute to a Roth IRA in a roundabout way, called a "backdoor” Roth IRA. It is complicated and you will need to talk to your tax advisor. Basically, you can open a non-deductible IRA and contribute to it, up to the maximum of $5,500 (or $6,500 if you are over age 50), then immediately convert it to a Roth IRA. Because you haven’t earned any interest, you don’t have any taxes to pay on the conversion. Now you have a Roth IRA!
However, if you own any other traditional IRAs, you may have to pay pro-rata taxes on the conversion. If you want to try a backdoor Roth IRA, transferring your old 401(k) to your new employer’s plan may be the best way to go.
If you plan on retiring early, consult with a financial professional who specializes in retirement income planning and an experienced estate planning attorney. You don’t want to make a wrong decision at this stage of the game that can limit your options and cost you money.
Reference: Forbes (August 31, 2018) “Should I Roll My Old 401(k) To An IRA If I Want To Retire Early?”