401(k) Rollovers at Retirement

by Dianne Molvig

As a soon-to-be retiree, you face a multitude of decisions about this new stage of your life. Where do you want to live? How will you use your time? What new interests will you pursue?

To that list of questions add one more: What will you do with your 401(k) money? You have two options:

• Leave the funds in your employer's 401(k) plan, or
• Roll the funds over into an individual retirement account (IRA).

Move your money or leave it?

Some employers require employees to withdraw their 401(k) money upon retirement. Others do not. Check with your employer to learn the rules. If you're allowed to leave your money in the 401(k) plan, should you do so?

"If the employer's plan has all the options you like, such as a wide range of investment options, and you're satisfied with the administration and services provided, you certainly could leave your money there," says Dennis Zuehlke, compliance manager at CUNA Mutual Group, Madison, Wis., a financial services provider for credit unions and their members worldwide.

On the administrative side, one aspect to look into is the fee comparison. "If you work for a large employer, there's a good chance you'll do far better on fees if you keep your money in the 401(k)," says Ed Ferrigno, vice president of Washington affairs for the Profit Sharing/401(k) Council of America, Washington, D.C. "That's particularly true if you work for a megalarge employer where your fees probably are ridiculously low."

What's more, many employers are stepping up to modify their 401(k) plans to make sure those plans remain attractive to retirees, Ferrigno says. And some employers are providing preretirement education, as well as advisory services for retirees who still have money in the plan.

You may prefer, however, to roll over your 401(k) to an IRA for various reasons. For instance, you may decide that an IRA would open up a wider range of investment possibilities than you have in the 401(k). If you choose a rollover, follow a few guidelines to make the process go smoothly.

Rollovers without hitches

As you near retirement, your employer will notify you about your 401(k) options. You'll be asked to fill out and return an election form by a certain date.

If you opt for an IRA rollover, have your employer send the funds directly to your IRA, through what's called a trustee-to-trustee transfer. This is a smarter option than having the employer send you the money, which you'd then put into an IRA. If your employer were to send a check to you, that would be considered a distribution. And the IRS (Internal Revenue Service) requires that 20% be withheld from distributions for taxes. With the trustee-to-trustee transfer, you'll make sure 100% of your 401(k) money goes into the IRA.

It's up to you to set up the IRA account. Do that in advance so you'll be able to give your employer an IRA account number for making the transfer. You might, for instance, choose to direct the funds to an IRA account at your credit union.

"One of the most common mistakes we see," Zuehlke says, "is that people don't involve their credit union early enough. Your check comes into the credit union, and the credit union doesn't know what to do with it."

If you haven't set up an IRA beforehand, someone at your credit union conceivably could deposit the funds into your checking or savings account. And if you fail to take action within 60 days to move the money into an IRA, taxation would kick in immediately. You eliminate this potential problem by making sure you've completed all the paperwork to set up the IRA before your money arrives.

Perhaps you have funds in both a traditional 401(k) and a Roth 401(k). "Then you need to make sure that the Roth 401(k) funds go to a Roth IRA," Zuehlke explains, "and the traditional 401(k) funds go to the traditional IRA."

You then can convert that traditional IRA to a Roth IRA, if you wish. In other words, as the rules stand, the traditional IRA must be an intermediate step when converting a traditional 401(k) to a Roth IRA.

But that soon will change. Beginning in 2008 , new rules go into effect. You'll be able to move money directly from a traditional 401(k) to a Roth IRA.

Note: To convert from a traditional IRA to a Roth IRA, your annual adjusted gross income limit is $100,000. The same limit will apply when converting a traditional 401(k) to a Roth IRA, per the 2008 rules. But the income limit for Roth conversions goes away in 2010.

Remember, whether you're rolling over a 401(k) to a traditional IRA and then to a Roth IRA, according to current rules, or directly converting a 401(k) to a Roth IRA as new rules will allow in 2008, either of these is a taxable event, Zuehlke emphasizes. "That 401(k) money, which hasn't been previously taxed," he points out, "is going to be taxed up front" when you convert to a Roth IRA. This will add a significant chunk to your taxable income for the year.

If you have company stock in your 401(k), you may be better off transferring the stock to a regular brokerage account, rather than rolling the stock over to a tax-deferred IRA. This is due to something called "net unrealized appreciation." Talk to your tax adviser.

Weigh your options

As the baby boomer retirement surge is under way, a lot of 401(k) money could be turning over into other financial products in the years ahead. If you're soon retiring, no doubt you've noticed a barrage of advertisers offering suggestions about what to do with your 401(k) funds. Some companies, for instance, are wooing soon-to-be retirees with offers of a free dinner at a local restaurant to get a chance to talk with you about their products.

"Our warning to people is to go slow," Ferrigno advises. "Do your homework. If you hire a financial adviser, make sure the person is an independent financial adviser because people are going to be after you. You have something they want."

Turn to a trusted adviser for help deciding what to do with your 401(k) money, and for general advice about preparing financially for retirement. Your credit union may have financial planning services available.

Weigh your options carefully. "You've worked all your life to save this money," Ferrigno points out. "So look before you leap."

Published August 20, 2007

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