- Congress established section 401k of the Internal Revenue Code to state that employees are not taxed for deferred compensation. Meaning, 401k account contributions and investments grow on a taxed deferred basis, but will be taxed at ordinary income tax rates upon withdrawal. Further, the Internal Revenue Service (IRS) penalizes 401k withdrawals that are made before the age of 59½, with a 10 percent "additional tax on qualified retirement plans" on your 1040.
You may be seeking greater control pertaining to this portion of the employee benefits package upon leaving your employer to take another job or at retirement. Rolling over your 401k into a traditional IRA account allows you to do so, while avoiding penalties and deferring income taxes for a later date. - Research and identify the different types of IRA accounts; and select one that is in accordance with your needs. All types of financial intermediaries, such as banks, mutual fund companies, brokerages and insurance companies, offer IRAs. Large corporations also have set up direct reinvestment plans (DRIP), which allow you to purchase stock directly from the company for your IRA account.
Knowledgeable investors that want total control to buy and sell securities for the IRA upon their own volition will be served best to open up an IRA with a discount brokerage. Savers that do not have the time or energy to research investments should hire a competent adviser to provide recommendations for the transition. - Financial intermediaries have set up the technology to make the 401k rollover into your new IRA plan relatively seamless. You will contact the financial institution of your choice and alert them of your decision to transact business. The brokerage, bank or insurance company then provides you with basic paperwork to complete in order to set up the account. The new IRA administrator contacts the old 401k administrator on your behalf to transfer the funds into the new account.
- Traditional IRAs feature similar rules to those of your 401k. The money grows upon a tax-deferred basis, until withdrawal. Withdrawals are then taxed at ordinary income, once you reach the age of 59½. Early withdrawals will be penalized with the same 10 percent "additional tax," which is levied upon 401k plans by the IRS.
Still, you cannot enjoy tax-deferred growth within the IRA account forever. Tax law states that required minimum withdrawals are to occur at the age of 70½. The IRS has special calculations to help you determine the amount that must be withdrawn and taxed at that point in time.
IRAs also carry annual contribution limits that are less than the 401k account. Congress and the IRS adjust and announce these limits every year. - Avoid cashing out of your old 401k yourself, because holding the check in your own possession for an extended period of time may trigger severe tax penalties. You are also responsible for withdrawing a certain amount of money from the IRA once you reach the age of 70½. Failure to do so leads to additional taxes and penalties.
Self-directed IRA accounts carry additional investment risks because of choice. Your new IRA account allows you to select from an infinite amount of assets to buy. You may wish to hire professional advisers to lower the risk of losing significant portions of your retirement savings.
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