You decided to leave your job and your Human Resources department asks you about your 401(k) rollover. You’re asked if you want a direct or indirect. Not knowing the difference, you complete the paperwork for indirect because you don’t know what your new hospital offers since you’re taking off a couple of weeks between jobs. But was indirect the best choice in your situation? In this blog post, we’ll explore direct and indirect 401(k) rollovers. We’ll review the dos and don’ts a rollover through theoretical case studies. And we’ll cover the steps to help you successfully roll over your retirement account funds.
What is a 401(k) Rollover?
Before we dig into the details of a 401(k) rollover, let’s define it. A 401(k) rollover is moving funds from your employer-sponsored retirement account to your new employer’s plan or an Individual Retirement Account (IRA). 401(k) rollovers are common, especially for nurses who often change jobs to follow career goals.
Why Should You Consider a 401(k) Rollover?
Let’s explore the many reasons to consider a 401(k) rollover.
If you have multiple retirement accounts, consolidating them into one can make it easier to manage your investments and track your progress towards your retirement goals.
More Investment Choices
Your former employer’s 401(k) plan may have limited investment choices. Rolling over your funds to an IRA or a new employer’s plan can give you access to a wider range of investment choices. Remember to consider your risk tolerance, investment goals, and time horizon when choosing your investments.
Some 401(k) plans charge high fees that can eat into your retirement savings. By rolling over your funds to an IRA or a new employer’s plan with lower fees, you can potentially save money over the long term. Compare the fees of your former employer’s plan with the fees of your new IRA or 401(k) plan. Consider all fees including account maintenance fees, investment fees, and transaction fees.
Rolling over your funds to an IRA or a new employer’s plan gives you more control over your investments. You can choose the investments that best fit your risk tolerance, investment goals, and time horizon.
How To Do a 401(k) Rollover
There are two ways to rollover a 401(k) plan, direct and indirect. Let’s explore these further.
With a direct rollover, your former employer’s plan administrator sends the funds directly to your new Individual Retirement Account or 401(k) plan. This is the easiest way to do a rollover. It is also the least risky for a few reasons. First, you do not take possession of the money. This lessens your chance of spending the money rather than saving it for retirement. Another reason a direct 401(k) rollover is less risky is because of the tax treatment. Direct 401(k) rollovers are not subject to withholding tax. You also keep your tax-deferred status. Meaning you won’t pay taxes on your savings until you withdraw them. This can help grow your savings tax-free. And finally, there is no penalty with a direct 401(k) rollover.
A Direct 401(k) Rollover Hypothetical Step-by-Step Case Study
Meet Sarah, RN. Sarah recently changed jobs and wanted to roll over her 401(k) from her previous employer to her new employer-sponsored plan. She decided to do a direct rollover. She did not want to risk using the money for unexpected expenses. Here are the steps Sara took to complete her direct rollover:
- Sarah contacted her previous 401(k) plan administrator and began the direct rollover process. She completed the rollover paperwork giving the necessary information about her new plan, including the name, address, and account number.
- Sarah gave permission to both plan administrators to coordinate tasks. Sarah’s previous 401(k) provider coordinated with her new plan administrator to transfer her balance directly. This avoided withholding taxes and paying penalties.
- Sarah waited for the money to arrive in her new employer’s plan. Once the money was in her new account, Sarah invested it after speaking with her Financial Advisor. Sarah spread her investments over several asset classes, including stocks, bonds, and mutual funds.
By doing a direct rollover, Sarah avoided spending the money, tax consequences and early withdrawal penalties. The direct process was easy and seamless because it was coordinated between the two 401(k) plans. This allowed Sarah to manage her retirement accounts more efficiently.
Indirect 401 (k) Rollover
With an indirect rollover, you receive a check for the balance of your 401(k) plan. Contributions go into your new 401 (k) or Individual Retirement Account (IRA). To keep the tax benefits, you must roll over the money within 60 days. Holding the money beyond 60 days opens you up to withholding taxes. You may also need to pay early withdrawal penalties if you are under 59 ½. But here’s the catch. According to the IRS, the previous plan administrator must hold back 20% of your balance. This means you must make up the 20% if you plan to put the original balance into your new account. Another tax consideration is that you can only do one indirect rollover every 12 months, not calendar year. This is important to remember for career planning. Although the indirect 401 (k) rollover gives you control over your money, it is also more regulated.
An Indirect 401 (k) Rollover Hypothetical Case Study
Meet Jane. Jane is a 44-year-old registered nurse who left her job after 8 years. Jane decided to roll over her 401(k) into an IRA. She opted for an indirect rollover of the balance of $40,000. Unfortunately, Jane was shocked when she received the check of $28,000. She didn’t realize that her previous plan administrator would withhold 20% for taxes and another 10% for early an early withdrawal penalty because she wasn’t 59 ½. Jane deposited the check into her personal savings account. She intended to open her new IRA within 60 days but too much time passed. Over the next few months, Jane used some of the money for an unexpected car repair costing $3000 and a much-needed $5000 vacation. When Jane finally opened her new IRA, her retirement savings dwindled to $20000! But when tax time came around, she was surprised to learn she owed federal and state taxes on the amount she used!
Nurses often change jobs which creates decisions about your 401(k) plan. Understanding the nuances of a 401(k) rollover is crucial for nurses thinking about their financial future. Consolidating your retirement accounts, accessing more investment options, and potentially saving on fees, may help set yourself up for a healthy and quality retirement lifestyle. However, before doing a 401(k) rollover, it is important to understand the difference between indirect and direct rollovers. Consider speaking with a Financial Advisor to help you choose which rollover aligns with your financial goals.
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All numeric examples and any individuals shown are hypothetical and were used for explanatory purposes only. Actual results may vary. Prior to rolling over any plan assets to an IRA, an individual should carefully consider various factors such as investment options, fees and expenses, services, penalty-free withdrawals, protection from creditors and legal judgments, required minimum distributions, and employer stocks depending on individual needs and circumstances.
Georgene Collins, RICP®, RN, PhD, MBA is a registered nurse turned Financial Advisor at Airey Financial Group. Georgene helps other nurses take control of their finances and prepare for retirement. Georgene began her career with Airey Financial Group in 2017 after retiring from 30 years in healthcare.
Georgene holds the Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services. She holds health and life insurance licenses and a long-term care certificate in Indiana and Illinois. Georgene is a Registered Representative and Investment Advisor Representative and has earned the FINRA Series 63 and 65 registrations.