Your 401(k) Coronavirus Guide: How to Rollover Funds

Fact: Unemployment is at an all-time high

Have you lost or left your job recently? If so, you may be wondering how to take control of the money in your 401(k) or other employee retirement account. First, recognize that the crisis of losing your job may also be an opportunity. You can move your retirement funds to a different account and potentially have more options to plan for your future than you did under your previous employer’s plan. With fewer and fewer people staying at one job for the long term, most people experience at least three to four employers during their career, so you are not alone.

What if your previous employer goes bankrupt?

The Employee Retirement Income Security Act (ERISA), founded in 1974, ensures that no matter what happens to your employer, your money is protected by the federal government. They cannot be touched by your past employer or anyone else but you. As long as you transfer your plan’s funds from one qualified plan to another, the tax status of the money will remain the same. That is, you will not be taxed currently on the payroll deductions or capital gains, unless you transfer them to a Roth IRA.

What are my options?

You have four basic options:

1. Leave your 401(k), 403(b) or 457 funds with your former employer.
2. Roll your assets into a traditional or Roth IRA.
3. Consolidate your current plan’s funds into your new employer’s plan.
4. Cash out your current plan.

What can I do if my retirement money is with my previous employer?

Good question! You have 60 days to decide if you would prefer to take control of your own retirement destiny or leave your vested interest in your past employer’s plan. You will still have access to the money but may incur administrative fees if you are no longer an employee.

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The four options explained

OPTION 1—Leave it Behind

You could leave your plan with your past employer, but you may incur administrative fees as a non-employee. If you choose this option, consider that you may have several employers over your career, and may wind up managing several plans, each with potentially different funding mechanisms and investment choices. This can be tedious and makes it difficult to keep track of your retirement funds. Many people choose to consolidate and place their money with one trusted advisor.

OPTION 2—Rollover

A rollover is essentially just what it sounds like. You are “rolling over” your funds to another qualified retirement plan and avoiding taxes and penalties. You can also opt to pay taxes and convert your plan to a Roth IRA. You will have to follow a defined process for transferring assets at the time of the rollover. The regulations protect you from having to pay taxes or penalties.

The process is quite simple: You select a credit union, bank, brokerage, investment advisor, or IRA rollover account. Then you set up an account with the chosen institution and send a formal request to the past plan administrator to transfer your funds to the account you just set up. A qualified plan means simply that the plan is an IRS-recognized plan that allows you (the participant) to place your retirement assets in a tax-advantaged investment account. The most common qualified plans are traditional and Roth IRAs.

There are basically two types of rollovers—direct and indirect:

Direct Rollover

A direct rollover is an electronic transfer of assets from one institution to another, whereby you do not have access to the funds. It is contactless, ensuring that you will not be responsible for taxes or penalties incurred if you withdrew the money and deposited them into a qualified plan within the requisite 60 days.

Indirect Rollover

In this scenario, the past plan’s administrator cuts you a check for the total amount, subtracting 20% for Uncle Sam (in case you don’t deposit it into a qualified plan). You are responsible for opening a qualified retirement plan or depositing the funds into an already established plan within 60 days if you want to avoid taxes and penalties. The trick with this option is that you need to deposit the full amount in order to avoid all taxes and penalties, which means you have to deposit the money you receive PLUS the 20% you did not receive from the plan. Once the rollover is complete, you will get the 20% back. If you don’t deposit the full amount, you will be taxed and penalized for any amount that was not deposited within the 60-day period.

Rollover Options

401(k) to 401(k)—This option is the easiest. It’s a simple transfer of assets from one qualified employer retirement plan to another. This can be done directly or indirectly. Before choosing this option, research the available investment options and talk to your financial advisor about how to invest in your new plan. As you age and as your needs change, your investment choices should as well. The funds available at your current employer will likely be different than the ones in your previous plan.

401(k) to Traditional IRA—This is another simple option, where you can roll all the funds accumulated in your original plan into a traditional IRA—a self-directed, tax-deferred individual retirement account that allows you control over your investments. This does not mean that you have to make investment decisions by yourself. You can consult with a registered and licensed financial advisor who can assist you in defining your time horizon and risk tolerance and help narrow the choices to what fits your specific needs.

401(k) to Roth IRA—Remember, a Roth IRA is different than a traditional IRA. Therefore, to move funds from a qualified 401(k) plan to a Roth IRA, there are two steps: first, you roll the money into a traditional IRA, and then you must convert the traditional IRA to a Roth IRA. Slightly more complicated but doable. It is important to reiterate that you will pay taxes during the conversion from the traditional to the Roth.

Traditional IRA to Traditional IRA—Similar to the 401(k) to 401(k) rollover, this is a seamless, direct rollover. If you choose to do it as an indirect transfer, remember that you are on the hook for a 20% withholding tax and you must get those funds deposited to the new IRA within 60 days or face taxes and penalties.

Traditional IRA to Roth IRA—To accomplish this, the traditional IRA must be converted to a Roth. In this case, the capital gains will be taxed before your funds are deposited into the Roth. Remember that once the money is in the Roth, they accumulate tax-free, so that when you withdraw them (after at least five years) they won’t be taxed again.

Special Circumstances

403(b) and 457 plans to an IRA—This type of rollover works just like a 401(k) rollover. Assets from your 403(b) (non-profit organizations plans) or 457 (government-sponsored plans) can be directly or indirectly transferred into a traditional or Roth IRA—but again, remember that if transferring to the Roth IRA, taxes must be paid first.

403(b) and 457 to 401(k)—These are similar qualified employer plans that allow for transfers to occur tax-free unless you have a check cut to you, in which case it is, once again, taxed a withholding percentage of 20%.

As a basic rule when conducting a rollover, you will not be taxed for transferring funds from an account that is taxed similarly to the account that you are rolling the money into (ex: a traditional 401(k), 403(b), or 457 to a traditional IRA). If you are transferring funds from a Roth 401(k) to a Roth IRA, you will not be taxed on the transfer either.

OPTION 3—Consolidate your plans

This option utilizes the same principles as above but instead of taking control in a self-directed plan, where you manage the investments, you simply roll your assets into the new employer’s plan and make investment choices on your own within the funds that are available in that plan. These can be somewhat limited by the plan’s offerings, which are usually a significantly smaller universe of investment choices than what you might find in a self-directed plan.

OPTION 4—Cash Out

If you are at least 55 years old and not working, or 59 ½ and still working, you may be able to cash out your retirement plan without penalty. Generally speaking, unless this is your intended plan, this option is the least attractive. If the funds have been in a traditional 401(k), 403(b), 457 or a traditional IRA, you will have to pay taxes on any gains. If you are cashing out a Roth IRA, you will not pay taxes on your withdrawals as long as you have invested in the fund for five years or more.

Required Minimum Distributions (RMDs)

The new Coronavirus Aid, Relief and Economic Security (CARES) Act states that for the year 2020, participants in qualified retirement plans have the right to defer required minimum distributions (RMDs) for this year. That is, you do not have to take your RMD funds for the year 2020.

Prior to that, in December 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act was passed into law stating that there are no more age restrictions on contributions. Going forward, you may continue contributing to your plan even after the age of 72. In addition, the SECURE Act states that you must begin taking distributions by April 1 of the year after you turn 72 years old. This is a change from the previous version of the law that required taking RMDs by the age of 70 ½.

NOTE: These acts can be a bit confusing, so here’s a breakdown. The CARES Act is temporary and allows you to defer RMDs for just this year. The SECURE Act was established prior to the CARES Act but is on hiatus and will go back into effect permanently after this year. The SECURE Act requires that you begin taking distributions the year that you turn 72.

It is important to know that you are responsible for determining the minimum amount you must withdraw based on the fair market value (FMV) of the total of all retirement assets you have as of December 31 of each year. For all the changes above, you may want to consult with your fiduciary broker, financial institution, financial advisor, or tax accountant to determine the correct amount and timing of your RMDs.

How do I choose who to work with?

Let’s start by acknowledging that this is a lot of information to absorb and it is not a complete analysis of your individual situation. It is best to consult with a trusted advisor who you feel comfortable with and who has a trustworthy financial institution supporting him/her.

• Do your homework first. Re-read this article and familiarize yourself with some of the terminology and processes, then ask good questions of your advisor. Don’t try to bluff your way through this. Seek assistance from your trusted advisor. Here are a few questions you may want to ask yourself before setting up an appointment: What is your time horizon?
• Do you expect to retire in 5, 10, 20, or more years? Set your goals in accordance with your chosen duration.
• What is your risk tolerance?
  • Will you lose sleep if the stock market drops another 1,000 points in a day or 2-3,000 in a few days? Or will you say, “oh that’s just a speed bump in the long journey to my goal.”
  • How much are you willing to lose in a short-term period without panicking?” Those with a longer-term horizon may be able to accept more risk than someone who will need their money in a shorter-term horizon.

Find your trusted advisor. Interview them and ask them for an objective analysis of your situation. Some advisors will charge a fee for the initial interview. Others will not. Some will be motivated by commissions, while others are motivated by management fees. Some will charge nothing for the initial interview and can provide an objective analysis without a commission or fee-oriented relationship. Ask them how they are paid? What motivates them to work with you?

Take steps toward your goal

Is the market too volatile right now to enter? This depends again on your appetite for risk and your time horizon. Some may say it’s a “bear market” and we will suffer declining stock prices as the economic impact of the COVID-19 crisis unfolds. Others may say it’s an opportunity to invest at a discount. Know that there are as many investment options as there are personalities. You can place your funds in ultra-conservative investments, aggressive investments, or any variation in between. Often a balanced portfolio of funds allocated across a broad spectrum of investments can be designed to meet the most stringent tolerances and perspectives. Ask the advisor you’re interviewing what he/she thinks might best suit your needs.

How conservative is too conservative? Keep in mind that both ends of the risk spectrum have pros and cons. If you know you’re averse to risk and can only accept the safest, most stable investments, like a CD, you won’t lose money but will still face inflation risk.

When you consider the rate of inflation and cost of living, a CD paying 1% for five years won’t outpace a 2% inflation rate. In other words, you will lose 1% in value on your money for each year because you are making 1% on your money but inflation is pushing the cost of everything you buy up by 2% so you can purchase less with your money when you withdraw it than you could have originally.

Example 1: If the price of a steak is $5.00 a pound today and you lock up that five dollars for five years in a 1% CD, when the inflation rate is at 2% a year, that same steak will cost you $5.52 in five years but at 1%, you will only have $5.26 to purchase the steak. So, whereas you can afford the steak now, you won’t be able to afford that same steak in the future with the same money.

Example 2: Looking more broadly, if your grocery expenses are $$10,000 a year and inflation stays at 2% a year, your grocery bill will look more like $$11,040 in five years. If your $10,000 CD was pays 1% for five years, it would mature at a compounded yield of $, $10,510, leaving you with a shortfall of $ $529.

The Bottom Line

• First: Do your homework, get to know the terminology, and determine your time horizon and risk tolerance.
• Second: Find a trusted advisor—someone who can be objective and whose business model charges reasonable fees or none.
• Lastly: Communicate with your advisor on how to properly roll over your funds into an appropriate plan and make an agreement to communicate regularly.

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About Bradley Carleton

Bradley Carleton is a branch sales consultant with VSECU and has been an outdoor guide and writer for 28 years. He lives in Charlotte, VT on a farm with his wife and a menagerie of pets. Other than finance, his greatest passions are his wife and traditional outdoor sports.

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