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One of the most important decisions to be made when you are retiring or changing jobs is what action to take with your 401(k), 403(b,) and other employer sponsored retirement plans. There are several options to consider, including leaving your account in your current employer’s plan, transferring it to your new employer’s plan, taking a cash distribution, or rolling it over to an IRA.

Tax considerations

Taking a cash distribution is considered income and will subject the account balance to taxation, possibly putting you in a higher tax bracket. Additionally, if taking the distribution prior to age 59½, it will be subjected to a 10% tax penalty.

Transferring your account to your new employer’s plan may be the most favorable option when you are changing jobs and have a relatively small account balance. This election will assist you in keeping track of and managing your account balances collectively.

The rollover IRA

If you are retiring or changing jobs with a larger account balance, a Rollover IRA may be the best choice for most people. If you leave your 401(k) in your current plan, communication from your former employer may be nominal, leaving you feeling uninformed and forgotten.

Additionally, 401(k) plan sponsors may provide education, but not personal investment and planning advice. The rollover maintains the tax-deferred status of those assets without penalty, allowing the assets to grow until you choose to take income distributions. An IRA Rollover puts you in control of your account, allowing you to manage it yourself. If you choose to work with a financial advisor, they will provide advice, investment management, and regular communication.

Investment options of IRAs

Investment options in 401(k) plans tend to be limited because the employer is attempting to serve the needs of numerous employees while minimizing their administrative tasks and expenses. Most plans provide a very limited selection of mutual funds including equity funds, bond funds, and target date funds. IRAs open a broad universe of investment choices including mutual funds, Exchange Traded Funds (ETFs), individual stocks, bonds, and alternatives. IRAs allow you to buy, sell and rebalance your holdings at any time. 401(k) plans may limit the number of times per year that you can reallocate your account.

IRA rollover value

When working with a financial advisor, IRA Rollovers may provide more value in the form of added services, including estate planning coordination of beneficiary designations, financial planning, and investment advice to support the plan.

Standardized IRA regulations

Employers have a great deal of flexibility in how they establish the operation and administration of their 401(k) plan, making the differences between plans difficult to understand. But for IRAs, the Internal Revenue Service (IRS) has implemented standardized regulations. Hence, all IRAs operate under the same rules.

When you take a distribution from a 401(k) account, the IRS requires that 20% be withheld for Federal income tax. With an IRA distribution, you can choose the amount of tax withholding, if any. This allows you to have an amount withheld that reflects the tax you may owe, keeping more assets in the plan, growing and lasting longer.

Estate planning flexibility of IRA rollovers

IRA Rollovers generally provide more estate planning flexibility for beneficiaries when electing an Inherited IRA. 401(k) plans may restrict beneficiary elections, when inherited, to minimize the employer’s administrative responsibilities and expense.

A client or prospective financial advisory client leaving an employer typically has four options regarding an existing retirement plan (and may engage in a combination of these options): (i) leave the money in the former employer’s plan, if permitted, (ii) roll over the assets to the new employer’s plan, if one is available and rollovers are permitted, (iii) roll over to an Individual Retirement Account (“IRA”), or (iv) cash out the account value (which could, depending upon the client’s age, result in adverse tax consequences). If the financial advisor recommends that a client roll over their retirement plan assets into an account to be managed by the advisor, such a recommendation creates a conflict of interest if the advisor will earn new (or increase its current) compensation as a result of the rollover. When acting in such capacity, a registered investment advisor, serves as a fiduciary under the Employee Retirement Income Security Act (“ERISA”), or the Internal Revenue Code, or both.

About Savant Wealth Management

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