What 401k Investment Options Are Available?
The options to investment in a 401k account are rather extensive. You can invest in most areas that a standard investor would consider. The placement of your retirement funds is dependent upon your comfort and risk level, and the types of investment that you would like to pursue.
One of the most common places that individuals invest their 401k funds is in mutual funds. A mutual fund provides a good balance of market participation, diversification, and risk management. As such, mutual funds are a popular target for many retirement accounts.
Stocks are another frequently used option in employer sponsored retirement programs. Stocks can come in the form of publicly traded stock or private corporate stock. There are few restrictions in the area of stock investment, but be sure to check with your plan supervisor for any specific rules.
Bonds are yet another investment vehicle that may be used in a 401k account. Most types of bonds are open to investment. Municipal bonds as well as corporate and other bonds are frequently used inside of a 401k account.
Money market accounts are also frequently used in 401k plans. Transfers inside of the account from another investment vehicle to a money market account have been known to cause difficulties. You need to be aware of equity wash rules in your plan.
Though this is by no means a comprehensive list of 401k investment options, it should be enough to get your off and running. Be sure to check with your individual plan to determine the real restrictions and investment guidelines. Each plan has specific rules that relate only to that particular plan. Your plan administrator should be able to clarify any questions that you have regarding your 401k plan. They can also be a good resource for your 401k rollover needs.
401k Rollover Rules You Should Know
There are a number of different 401k rollover rules that you need to be aware before making a change with your current retirement plan. The tax consequences from mistakes can be extremely costly and will make recovering your retirement funds difficult. Be sure that you know what you are going to do with your funds before starting the transition period.
Let's take a quick look at some of the general rules that you will need to be aware of as you rollover your 401k. These are general rules that should apply to most 401k plans, but be aware that your specific plan may also have specific rules relating to changes from the account.
The 60 Day Rule
The first rule is one that most people have heard of if even only in passing. It is the 60 day rule. This rule is pretty straightforward in its application. It simply states that you have 60 days to transfer your funds from one retirement account into another account. The clock starts ticking on the day the distribution hits your hands.
The IRS has been notoriously unforgiving of the 60 day rule, even rejecting individuals on the 61st day. Be sure to not procrastinated depositing the funds into your new plan. This is also the reason that it is good to have your plan of action decided before taking the distribution from your current retirement plan.
In recent years, the IRS has "graciously" provided a compassion ruling meant to provide a couple of waivers to the 60 day rule. In Revenue Proc. 2003-16 lays out the following circumstances I which a waiver is likely to be granted:
- Financial institution error
- Death
- Disability
- Incarceration
- Hospitalization
Don't expect this to be a free ticket however. The waiver comes with a fee ranging from $500 to $3000 depending on the size of the account being rolled over.
20% Withholding Rule on 401k to 401k Rollovers
Exactly as the title states, when you are rolling your 401k into another employers retirement plan there is a required minimum withholding of 20% of the funds. The old plan is required to pay (on your behalf) the 20% tax liability you've acquired for your early withdrawal out of the plan. I suppose the government doesn't trust that you will make the payment from your retirement funds.
Once you have completed the rollover to the new employer's plan, you have to wait until next tax season to have the 20% returned to your via your tax refund. For this reason rolling your 401k over into another 401k can force an unfortunate money shortage to make up for the temporary shortfall the tax creates.
What Are The 401k Rollover Options?
When you have determined that a change is coming to your qualified retirement plan, either via a job change or other permissible event it is important to ask yourself about what 401k rollover options you have. There are number of different things that you can do with your account, the last of which is to let the decision slide. Procrastination in 401k rollovers is not a virtue.
The first thing that you must consider when you are changing from your current pension or retirement plan is that the decision has a timetable to it. The longer you take to figure out your options, the less options and the greater the consequences you will face.
Most 401k rollover options have a time limit of 60 days after distribution to complete the account transfer. This rule is only bypassed if the time passes in the hands of those actually handling the transfer. Meaning that once you have done everything that you can do, clerical mistakes by the processing company will not cause penalties from the 60 day rule. This doesn't not mean that you will not have problems with the IRS and have to fight for your position as legitimate. The safe thing to do is to give yourself a significant buffer to do the rollover.
Depending upon your situation, there are a number of different options that a 401k rollover can offer. The most time tried and frequent transfer over the years has been a transfer from one 401k plan to another. Once you start your new job, you are able to transfer your existing plan to the new plan. The tax implications to this type of transfer generally isn't too significant. The major difference can come in the specific rules and options the new plans provides.
There are often 401k rollover options that provide the plan participant with more flexibility with their retirement funds. These options include 401k rollovers to traditional IRAs and even 401k rollovers to Roth IRAs (see information center for more information on these options). A rollover to an IRA account can provide the ability to extend the account beyond the life of the participant, can hold significant tax advantages, and may provide added security and flexibility with early funding needs.
A 401k plan may also be transferred into several other types of qualified retirement plans. This currently includes: 401k, 403a, 403b, and SEP. Each different type of 401k rollover will have its own significant advantages, disadvantages, and restrictions. It is important to careful analyze your options and determine the best placement of your retirement income.
To sum up the 401k rollover options available...
- 401k
- 403a
- 403b
- SEP
- Traditional IRA
- Roth IRA
- Other?
When determining the best way to rollover your 401k, it is recommended that you consult a qualified and knowledgeable financial advisor. They will be up to date on the current tax laws and will be best able to guide you to making a smart rollover decision.
Can You Do A 401k Rollover To A Roth IRA?
A question that many qualified plan holders ask when leaving their job is whether or not they can do a 401k rollover to a Roth IRA. And up until 2008, the answer was much stickier and involved a number of lengthy steps, restrictions, and hurdles. But beginning in 2008 and if certain guidelines are followed, the 401k rollover to Roth IRA is a distinct possibility.
The History of the 401k Rollover to Roth IRA
The biggest hurdle for politicians to overcome in allowing this type of rollover came in the tax functionality of the two accounts. The 401k account is a tax-deferred account in which contribution are made pretax and distributions are taxable upon receipt by the beneficiary. In contrast, the Roth IRA account allows for taxable contributions into the account, but then provides both tax-free growth and distribution.
There is also the matter of required minimum distributions with the qualified plan that the Roth IRA does not share. The IRS (read: politicians) were concerned that if you transferred tax-free dollars into an account that provides tax-free distributions, where will the government get their money?
The answer to this came quite simply. Only some of the dollars could be rolled over from the 401k to the Roth IRA tax-free. Each dollar in the 401k has a portion that is considered taxable and a portion that is considered tax-free. In order to do a 401k rollover to Roth IRA, the taxable portion of the funds must be taxed upon transfer.
Who Should Do The Rollover (and How To Do It)
This tax liability from a 401k rollover has made this type of transfer discouraging to potential investors. However, the tax benefits of the Roth IRA in areas of growth, distribution, and longevity (ability to pass the account to future generations) can create a mighty incentive to rollover to Roth IRA. And as such, more and more financial planners are recommending that if their clients are able to take the initial tax hit, the rollover to a Roth IRA is well worth the trouble.
Similar to a 401k rollover to traditional IRA (see information center), the rollover to a Roth IRA must be completed within 60 days of the distribution out of the account. Rollovers done after this time-frame will be subject to hefty penalties.
Also similar to traditional IRA rollovers, direct rollovers and trustee to trustee transfers of retirement funds are also often possible.
Determining when and if you should do 401k rollover to Roth IRA is an important question, and likely one that you should discuss at length with your financial advisor. The implications, both tax and otherwise need to be considered before making this type of transition. The IRS has a history of being unforgiving with mistakes and misunderstandings.
How To Rollover A 401k To A Traditional IRA
To help facilitate the portability and transferability of 401k accounts (as well as other pension types) individuals may now do a 401k rollover to traditional IRA accounts. This 401k rollover is designed to help individuals leaving their current job who need greater flexibility and control over their retirement accounts upon the transfer.
While you may still rollover your 401k account into another 401k account, many find that the ability to rollover into a traditional individual retirement arrangement allows them flexibility, options, and control that the 401k cannot provide.
One significant motivation for many individuals for transferring their accounts into a traditional IRA versus leaving them with another 401k plan is that there are more options for the beneficiary. If the account hold were to die while the pensions funds were still in the 401k, the beneficiary would be limited by and subject to whatever distribution options the plan provides. The distribution options are often limited and detrimental to the health of the funds. Often 401k accounts require a lump sum distribution upon the account holder's death, or some other tax inconvenient option.
The 401k rollover to traditional IRA often provides the beneficiary the ability to continue distributions throughout the life expectancy of the beneficiary. Rather than take a lump sum distribution, the account is allowed continued growth. The reason that pension plans do not often offer this type of distribution option is that this type of account management is expensive for the company holding the account. The sooner they do not have to manage the funds the less expensive it is for the company.
How Do I Do A 401k Rollover to IRA?
Today most employer-sponsored retirement plans allow the option to rollover to a traditional IRA account. This is becoming less and less exclusive to traditional IRAs, as of 2008, you can now do a 401k rollover to Roth IRA (see topic in information center).
With most distributions from your retirement plan, you are able to rollover your 401k to either an existing IRA account or a new account. There are certain restrictions however that may prevent you from completing the rollover.
First, your funds must not be from a series of periodic payments that occur over the life expectancy of the participant or those that occur for over a period of ten years or more. The funds also may not come from a hardship withdrawal from your 401k plan.
The easiest way to accomplish the rollover is to do what is called a direct rollover. This allows the plan participant to directly rollover the funds into a traditional IRA. Electing a 401k direct rollover is now quite simple, as a new law requires qualified plans to allow direct rollovers to IRAs. Also by doing a direct rollover, the participant is able to avoid the 20 percent income tax withholding requirement on a distribution paid directly to the participant.
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