What are the tax implications of moving my 401(k) into an IRA?

I want to move my 401(k) into an IRA. Then I want to cash out a portion of those funds. What kind of IRA would allow me to do this? What are the tax implications?

401(k), IRAs, Taxes
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May 2018

Rolling your 401K into an IRA won’t be taxable.  Once you’ve done the IRA rollover, distributions are taxable at ordinary income rates.  If you’re under 59.5, there will be a 10% penalty on most distributions.  The 10% penalty won’t apply if you meet an IRA distribution exception like distributions for qualified education costs, a first-time home purchase, or for health care premiums made during a period of unemployment.

There are a few other rollover issues to consider as well:

Asset protection.  Depending on the state you live in, once your funds are in an IRA, there is might be less asset protection from a judgment resulting from a lawsuit.  

Required Minimum Distributions (RMDs).  If you are above 70.5 and still working, you might be giving up the ability to rollover your existing 401K into your new 401K (if the plan allows it) and delay paying the taxable RMDs until you are not working.

Invest choice and fees.  While rolling the 401K to the IRA will increase the number of investment choices available to you, before you do the rollover you might want to compare the administrative costs and investment fees of your current 401K to the all-in costs of what you’ll be paying once the funds are in an IRA.

Roth IRAs.  Once you have rollover IRA money, you’ll lose the ability to do a “backdoor Roth,” wherein you would make a non-deductible contribution to an IRA and then convert the funds to a Roth IRA, pay the tax on the conversion, and then get the benefit of not paying tax on any of the gains going forward.  On the other hand, you can do a Roth conversion on some or part of the IRA, where you would convert money from the rollover IRA to a Roth IRA, pay the taxes, and then get the benefit of not paying tax on any of those gains going forward.  The Roth conversion is something you may consider if you expect your tax rate to go up in the future, or you could do the conversion in years you’re in a lower tax bracket if you have year-to-year swings in income.

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