IRAs, 401(k) & Qualified Plans Rollovers
Saving for the future is critical to your overall retirement planning strategy. But simply building up a big stash of cash or investments won’t necessarily ensure you will live a comfortable or worry-free lifestyle. That’s where generating an ongoing income is necessary.
Suppose you’ve invested in an employer-sponsored retirement plan like a 401(k) or a personal IRA (Individual Retirement Account). In that case, you could have built up a sizeable nest egg throughout the years.
So, when you retire, you may want to convert some—or even all—of these funds into an income stream to supplement Social Security or other incoming cash flow sources. One way to do this is through a rollover to an income-generating financial vehicle like an annuity.
There may also be other reasons to consider a rollover, such as switching to a different employer or wanting more control over the assets and financial vehicles you put your savings into.
But before you take on this task of rolling over tax-advantaged savings yourself, some IRS rollover rules must be followed. Otherwise, you could find yourself paying taxes or penalties unnecessarily. This, in turn, can reduce the net spendable income you’ll have available in retirement.
How 401(k) and IRA Rollovers Work
In the financial sense, a rollover refers to transferring funds from one retirement plan to another without incurring a taxable event. When a direct rollover occurs, it means that funds are sent directly into a new investment account or vehicle. So, for instance, an IRA rollover entails transferring funds from one IRA to another.
You could also roll funds over from an employer-sponsored retirement savings plan—such as a 401(k)—into your own personal IRA. This can give you more control over what assets you invest in going forward. It could also help you to save money on investment management fees, which are prevalent in employer-sponsored retirement savings plans.
When an investor initiates a direct rollover from an employer-sponsored plan like a 401(k), the retirement plan administrator may pay the proceeds from its account to the new plan [such as a 401(k) plan at the individual’s new employer], or conversely, the money may be sent directly into the individual’s IRA.
This distribution could be issued as a physical check that is made payable to the new account. In some cases, a check may be made out to the investor. The investor will have 60 days to place the funds into the new account.
If this does not happen, the money will be taxed as if received as a distribution. If the funds were contributed to the former plan pre-tax, and the money grew tax-deferred, then 100% of this distribution will be taxed.
Using Rollovers in Retirement to Generate Income
Many people roll money from employer-sponsored plans or IRAs to an annuity to generate an ongoing retirement income stream. Because many companies have done away with the traditionally defined benefit pension plan—which generated a preset amount of regular income for retired employees, often for life—it is now up to most retirees to develop their own income plans.
Annuities have become a popular means of doing so. That is because annuities are designed to pay out a set amount of income regularly, such as monthly, for either a fixed period (like 10 or 20 years) or for the remainder of your lifetime—no matter how long that may be.
This can help to alleviate the fear that many retirees have regarding the depletion of income and assets while they are still needed. Knowing that you will have income for life can also allow you to worry less about financial matters and concentrate more on spending time with your family and participating in fun activities.
One common annuity option is the SPIA (single premium immediate annuity). In return for a lump sum contribution (including money from an IRA or retirement plan rollover), an SPIA will start paying out an income stream right away within the following 12 months.
Immediate annuities differ from deferred annuities because the latter’s income stream may not begin until some time in the future—if ever. Deferred annuities have an “accumulation” period where the funds inside of the contract grow tax-deferred.
The amount of income that is paid out will depend on several factors, such as the:
- Dollar amount that is rolled over into the annuity
- Annuitant’s (i.e., income recipient’s) age
- Length of the income payout period (either a set number of years or for life)
- Number of annuitants (one single recipient or a joint life option with a spouse, partner, or other receiver of the payout)
- Interest rates
- Income recipient’s gender (on average, women have longer life expectancy, so the dollar amount of the annuity payout may be less than that of a man, with all other factors being equal)
- Other features on the annuity (such as a death benefit)
- Insurance company where the annuity is being purchased
The income you receive from rolling money over into a single premium immediate annuity could help you supplement your Social Security retirement benefits or other incoming cash flow sources that you may have in the future.
Rollovers and Taxation
As with any other type of financial transaction, it is essential to consider taxation’s role if you opt to move forward with an IRA or 401(k) rollover. That’s because taxes can significantly impact the amount of money you have available to spend on the goods and services you need.
Some key criteria can determine whether or not a rollover may be taxable. These include:
- Whether the funds are coming out of or into a traditional or Roth account
- If you take actual receipt of the money (and do not place it into a new account within the allotted period)
For instance, the transaction is not considered taxable if you roll funds from a traditional 401(k) plan into a traditional IRA. However, if you are rolling money from a traditional plan into a Roth, you must pay taxes on the money that has not yet been subject to income taxation. (In this case, your future withdrawals from the Roth account will be tax-free).
Regardless of whether or not the transaction is taxable, though, retirement plan distributions should be reported on your annual income tax return on IRS Form 1099-R. The rollover will be reported as a distribution—even if all funds are moved into another eligible retirement account.
Does a Rollover Make Sense for You?
There can be several benefits to rolling over funds from one account to another—starting with the tax-free nature of various rollover transactions. There are several situations when a rollover can make sense, such as:
- Leaving an employer and going to another that also has a retirement plan
- Attaining more control of your investment vehicles by moving from an employer-sponsored plan (that may have limited options) to a self-directed IRA
- Wanting to pay tax now (in a low tax rate environment) as versus later (when tax rates are likely to be higher) by moving traditional IRA or 401(k) funds to a Roth account
- Converting a lump sum of money from an IRA or employer-sponsored retirement plan into a guaranteed, ongoing stream of retirement income
Because everyone has different short- and long-term financial objectives, as well as risk tolerance and time frame until retirement, a rollover may or may not be right for you. The best way to determine this is to consider your savings and income goals and then discuss your specific situation with a financial advisor specializing in retirement income planning. That way, you can better narrow down the right plan and the financial tools to help get you to your destination.
Where to Get Started with a Retirement Plan or IRA Rollover
Rolling funds from one account to another can have several “moving parts” associated with it. So, it is essential to ensure that you take all the necessary steps in the process and not get taxed or penalized unnecessarily.
That’s why working with a retirement planning specialist can help. Doing so can better ensure that you don’t leave out any critical parts of the process—and that you don’t have any future (and unwelcome) tax-related surprises.
If you would like to set up a no-cost, no-obligation chat with an expert in retirement plans and rollovers, feel free to contact us directly by calling <phone number> or emailing us through our secure online server at <email address>. We look forward to helping you maximize your retirement savings and income strategy.
