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?
I saw many good answers and thought I would add what I did not see.
Plan rules would determine whether the plan allows "in-service distributions," which is what you would be doing. Usually, any money you would take out that has been rolled into the plan from another plan or from an IRA would NOT be considered an "in-service distribution," so that money can be accessed.
Have you considered a loan from your 401(k)? This could be more cost effective than taking out money from your 401(k) or your IRA after you roll it over. The taxes (and 10% penalty if you're under 59 1/2 can be high). Many plans allow loans. The interest woud be paid to yourself by yourself. You might miss some investment gains, but it is worth considering.
Possible short-term loan. If you need the money for a short period of time (e.g. you are waiting for a customer to pay $20k he owes) you can take money out of an IRA and pay no tax or penalty if you put it back within 60 days. YOU can only do this once a year, but YOUR SPOUSE could also do this if you are married and give you 120 days.
Again, I liked the answers I saw and thought you might benefit from a few additional thoughts on this topic.
Best of luck!
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.
No tax implications if you do a direct transfer "custodian" to " new custodian" or if the funds are deposited within 60 days with an indirect transfer "custodian" to "you" to "new custodian". If you decide to convert your IRA to a Roth IRA, then you will have to pay taxes on your conversion.
You want to do a “custodian to custodian” direct rollover to an IRA Rollover. Do not let your 401k provider send you a check & then you have 60 days to roll it into the IRA. This is because 401k are required to withhold 20% & send to the IRS (Treasury) regardless of what your actual tax rate is.
You would then have 60 days to roll the 80% check you received but would have to come out of pocket the other 20% for a 100% rollover. Therefore you would essentially be giving the IRS an interest free loan until you file your taxes and would get a big refund for the approximate 20% after netting on your return. The 20% would be similar to withholding & then you figure what actual tax you owed and did you over or under withhold.
If you roll the assets directly to an IRA at the new custodian (brokerage firm), it is not considered a distribution and there is no withholdings. From the IRA, you could then you take a distribution for whatever amount necessary. But you can set your own withholding rate – 20%, 15%, 8%, or even 0% - depending on how much you think you would actually owe. If you are under 59 ½, there is also a 10% penalty. There are a few exceptions to the 10% penalty like t time homebuyer up to $10k, unreimbursed medical expenses, medical insurance premiums, qualified educations expenses, plus a couple of others, but you always have the income taxes owed.
All distributions from any retirement plan – 401k, 403b, IRA, etc… are considered ordinary income taxed at your tax rate after taking into consideration the distribution. But you have much more control of the distribution. So it is almost always better to roll the 401k assets DIRECTLY to the IRA first, then take any necessary distributions.
If you roll the assets to a Roth IRA, the whole thing is taxable. So depending upon your age & other variables, I would roll to an IRA Rollover. From there is you want to do a partial or even whole Roth “conversion” you can. But for now, a “direct custodian to custodian” to an IRA Rollover (also called a Conduit IRA).
Hope this helps and best of luck, Dan Stewart CFA®
If done correctly, the money that you rollover from your old 401(k) to your IRA will not be taxable (as long as you roll into a Traditional IRA, and not a Roth). and will not be penalized. Make sure this is done as a "Direct Rollover" to avoid any reporting/tax issues. Then, when you "cash out a portion of those funds”, you will likely owe taxes, but will only be penalized if it is a premature withdrawal (usually prior to age 59 1/2, but with some exceptions).