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Starting in Jan of '08, thanks to the Pension Protection Act of 2006 (PPA'o6), the working man has a new option for his retirement funds.
The 'Old' Way
Previously, if you left your job or had a 'qualifying event' (an event that allowed you to withdraw your 401k money, depending on the funds' rules), the only place you could put the money from your old 401k would be either; Another 401k, or a Traditional IRA. That or take a cash disbursement + early withdrawal penalties + paying taxes due.
Assuming you wanted the money to end up in a Roth IRA, the jump path would be
Original 401k -> Traditional IRA -> Roth IRA.
And in addition, you couldn't roll the Traditional IRA to a Roth, if you had a Modified Adjusted Gross Income of over $100k for the year. Another stumbling block.
Not much flexibility there. But now with the PPA'06, the money can be moved directly into a Roth IRA.
The 'New' Way
Here's the steps
- Open a Roth IRA at your bank or financial institution.
- Contact the institution where your 401k is currently held and ask what their procedures/paperwork is for making a Direct-to-Roth IRA Rollover. (Understand, that this might be new to them, so a little patience may be involved.)
- Receive the paperwork, fill it out, and return it.
- Wait for a few weeks, and
- See the money arrive in your Roth IRA account.
Pretty straightforward and easy.
Now the catch.
You will have to pay taxes on the amount that you roll over into the Roth, since going from a pre-tax source to a post-tax source will cause the government to come get their due.
Strategies
If you've got a significant amount of money to move, the tax-hit might be pretty high, so to alleviate the hit you can move the money into a Traditional IRA, then 'stage' the move over a few years, to spread out the tax hit.
By spreading the taxation out over a few years, pay a slight amount more (because hopefully the pre-tax money will accrue a little more interest) but it will be broken up over a space of years, and be less of an individual hit.
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December 26th, 2007 at 2:19 pm
I'm going to start looking for a new job soon, and if I start somewhere new, I will have to decide if it will be better to roll my 401(k) into my new fund, or roll it into an IRA. Depending on what the options are for the new fund, I may roll it into an IRA. I always prefer Roth over Traditional, so I may be in for a BIG tax hit if I go that route.
I will have to do a lot of research if I get a new job. Very informative article.
December 26th, 2007 at 3:21 pm
@Patrick,
It's ALMOST always a better idea to roll it to an outside IRA. You almost always have more choices and control over it. I personally can't really think of a situation where you would WANT to move it to your new employer's 401k, even though many offer it.
The only thing I could think of would be if you were planning to use the 401k as a basis for a loan (from the plan) for a house purchase or something, and even then, it's a bad idea.