One of the most perplexing issues that arise when in transition is financial planning. If you have a Finance background, maybe this does not apply to you. But for most of us, financial considerations, run neck and neck stress-wise, with finding employment.
Wouldn’t it be great to have the opportunity to ask financial questions to a qualified financial planner to help you make those important financial decisions, especially in the midst of tax season?
Well, guess what!
At the next Breakfast Club NJ meeting, Saturday February 13, 2016 at 8 a.m., you will have that opportunity to ask those questions to Bill LaChance, an independent financial advisor based in Chatham NJ. Bill offers a unique flat fee program and focuses his practice those going through or contemplating a career transition. Prior to launching his financial planning practice, Bill spent twenty two years in corporate finance in the retail industry and before that was a CPA with a large accounting firm. Bill has a B.S. in Accounting from Bryant University, an MBA in Finance from Indiana University and completed the Financial Planning Certificate program at Fairleigh Dickinson University. Bill is also an Enrolled Agent authorized to represent taxpayers before the IRS and provides tax consulting and preparation services.
Following this note, is one of Bill’s blogs from last year to help you start thinking of questions you can ask him on Saturday.
See you Saturday!
Pros and Cons of Rolling a 401K/403B to an IRA
By Bill LaChance
One question many folks have when leaving a job is what to do with their 401K/403B. It most instances rolling over your 401K to an IRA makes the most sense, but in some situations the better option is to keep the money in your current 401K or roll the money into a 401K at your new company.
Taxes work for a 401K/403B plan the same as for a traditional or rollover IRA. You put money in pre-tax, the earnings grow tax deferred, and you pay taxes on any amount withdrawn.
While the taxation rules are the same, some of the features of the various plans differ. This blog focuses on those features that would influence your decision to roll over your 401K/403B. Since none of the differences between 401Ks and 403Bs are relevant to this discussion, going forward I will only refer to 401Ks. Keep in mind that the features I describe apply to 403Bs as well.
When you leave a job you have four options with what to do with the money in your 401K.
1. Do nothing and leave the money in your former company’s 401K.
2. Rollover the money to your new company’s 401K.
3. Rollover the money to an IRA.
4. Withdraw the money.
The fourth option should be avoided if at all possible. Besides paying taxes on the money you withdraw, you will no longer have that money available for your retirement and you may have to pay a 10% penalty. This option will be a topic for a future blog.
Here I focus on the pros and cons of the first three options.
Do nothing and leave the money in your former company’s 401K
There is one situation where I believe it makes sense to keep the money in your old company’s 401K. That is if you leave the company any time during the year you turn age 55 or later. The reason has to do with the 10% early withdrawal penalty. The IRS imposes a 10% penalty (on top of having to pay income taxes) for retirement plan withdrawals made prior to age 59 ½, (with certain exceptions). One of those exceptions is that you can make a withdrawal from a 401K before age 59 ½ without paying a 10% penalty as long as you left the service of your employer during the year you turn 55 or later. This exception does not apply to IRAs. I did speak to someone recently whose advisor recommended rolling over her 401K to an IRA. Later, when she needed to withdraw some cash, this person found out that she was responsible for the 10% penalty, a penalty she could have avoided had she left the money in the 401K.
Rollover the money to your new company’s 401K
401K plans allow loans and IRAs do not, so if you think you may need to borrow against your 401K in the future, you may want to roll over your existing 401K balance to your new company’s 401K. Since most companies do not allow you to borrow against your 401K if you are no longer employed with that company, leaving it with your old employer may be less desirable.
Rollover the money to an IRA
If neither of these two situations applies to you, it is usually better to roll over your 401K to an IRA. IRAs have several advantage over 401Ks. The first is that you have much broader investment options, including the full complement of low cost index funds from providers like Vanguard, Fidelity, or Schwab. Second is the availability of conversions to a Roth IRA. With a Roth IRA you pay your income taxes up front. With a traditional IRA, you pay your income taxes upon withdrawal. If you find yourself in a low tax bracket for a period of time, converting some (or all) of a traditional IRA to a Roth IRA and paying the taxes at that point may be a viable option.
Finally, IRAs have exceptions to the 10% early withdrawal penalty that 401Ks do not. The first is that you are allowed to withdraw up to $10,000 penalty free if used for a first-time home purchase. The second exception is that IRA funds can be withdrawn penalty free if used for qualified higher education expenses for you or someone in your family. The third exception is using IRA funds to pay for health insurance premiums, as long as you collected unemployment insurance for at least twelve consecutive weeks. In each of these instances you will not pay a penalty, but will still have to pay income taxes on the withdrawals from the traditional IRA.
If you are not sure which approach is better, you can hedge your bets and roll over part of the 401K to an IRA and leave the remainder in a 401K. Unless you are in a situation where you must make a withdrawal, it is advisable to wait until you secure a new job until making any decision on rolling over your 401K money.
Please feel free to reach out if you have any questions.
This blog has been republished with the permission of Bill LaChance.