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All Rollovers Aren't the Same - 401(k)s Are Different Than IRAs
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By Clifton Linton
Senior Writer, mPower |
One common complaint we hear from
readers is how long and complicated the process of withdrawing or rolling money out of
their 401(k) plan can be, especially when compared to making an IRA rollover or
withdrawal.
Their observations are right on the
mark — 401(k) withdrawals and rollovers are more intricate than with IRAs.
That's because the 401(k) rules were deliberately designed to make it more difficult for
anyone to access your money, including creditors. That's true whether the creditors are
yours or your employer's.
While there isn't any magic bullet to
make a 401(k) withdrawal or rollover go more quickly, understanding the rules about how
they work will help you develop a strategy to make your rollover as smooth as possible.
Asset Ownership Differences
Rollover procedures are different
because assets are held differently in a 401(k) plan than in an IRA. "The money you
have in a 401(k) is held in a trust for your benefit," said Ted Benna, the creator of
the first 401(k) plan and president of the 401(k) Association. "With an IRA, the
ownership resides with you."
Indeed, IRA assets are your property
and you can direct your IRA custodian to maneuver your assets as you wish. Typically, all
that's required is your signature to authorize a change in investments, or to make an
account withdrawal or rollover.
Because your employer sponsors
the 401(k) plan, the assets are not actually your property, but instead are owned by the
plan. Federal law requires that your contributions be held in a trust and administered by
a trustee, who is charged with managing the assets on your behalf.
The trust holds your 401(k) money
apart from your employer's general assets. That means, for example, that your employer
can't use them as collateral for a business loan and the money can't be seized by
creditors if your employer goes bankrupt.
The drawback to these protections is
that there has to be an additional level of administrative oversight. That's why 401(k)
money is tougher to get than IRA money.
The Withdrawal
In order to get your money from your
401(k) plan for a rollover, you need to have "a benefit event," as it is known
in the human resources industry. That usually means you retire, reach age 59ý, or
otherwise leave your job.
When the benefit event occurs, you'll
need to tell your employer how much you are taking and where you want the money to go by
filling out a 401(k)-election form. Common options include lump-sum distributions, regular
periodic distributions or rolling the money to another 401(k) plan or an IRA.
After submitting this paperwork to
your employer, it's processed and a formal notification is made to the plan trustee (often
a high official at your firm) that a distribution can be made. The trustee, in turn,
forwards the distribution notice to the firm that administers the plan.
"Before we can release the money,
we must receive notification from the employer (or trustee)," said Dean Schmitz,
assistant manager of sales with Principal Connection, a business unit of the Principal
Financial Group.
At a minimum you should expect a
401(k) withdrawal to take two or three weeks regardless of where the money will end up,
industry experts say.
A slow rollover tends to be the
exception rather than the rule, said George Diones, vice president of the client
management group with Diversified Investment Advisors. After all, many employers are as
eager to give you your money as you are to remove it from their plan, he added. One common
reason employers want you to close your account after leaving is to reduce the
administrative expenses the plan pays.
With an IRA rollover, you only need to
notify your custodian that you are making a withdrawal or rollover. And sometimes (as
explained below) you don't even need to do that.
Rollover Comparison
There are two ways to move money from
one 401(k) to another or to an IRA. Either the money moves via a direct transfer or the
money is sent to you and you move the money to the new account. For this example, let's
assume that you're using the direct transfer method. In other words, the money moves
directly from an IRA to an IRA or a 401(k) to an IRA, without you touching it.
This process is known as a direct
rollover or trustee-to-trustee transfer. When you move your money this way, you never have
to worry about the tax consequences of your transfer.
We will take a look at two basic
transactions, moving money out of a 401(k) to some other tax protected account such as an
IRA or another tax-qualified plan such as another 401(k), and moving money between IRAs.
If you've ever made an IRA-to-IRA
rollover, you know that the process is relatively simple. Actually, your new IRA custodian
will often take care of the entire transaction for you. You fill out a form giving the
custodian permission to transfer the assets from your old IRA, and the money is usually
moved within a week or two.
That's half as much paperwork as
you'll have to do for a 401(k) rollover. For those, you need to fill out an election form
with your old employer and then fill out another set of paperwork with the firm accepting
your rollover. You should expect your 401(k) rollover to take a minimum of two weeks and
possibly three. Currently, it takes the Principal two weeks to process a 401(k) payment
once it receives the paperwork from the employer, Schmitz said.
Some 401(k)-plan providers will help
you set up an IRA with their company, because they want to keep your money invested in
their funds. They will also help you fill out the 401(k) to IRA rollover paperwork. This
may not be a bad strategy if you like the investment options currently available to you.
Smooth Rollover Strategies
One key to a smooth and timely 401(k)
or IRA rollover is filling out all the paperwork correctly and completely.
"The participant has the
responsibility to read the papers and check them off," said Trisha Brambley,
president of Resources for Retirement Plans Inc. "If you mess up, the former employer
will issue you a check ... and then it's a big mess."
Make sure you have a new IRA account
set up to receive your money or a new 401(k) open at your new employer before you initiate
the rollover. This way, you'll know the appropriate account numbers and addresses to
receive your money.
With a 401(k) rollover, be sure you
have correctly filled out the election form. If you are rolling your money to an IRA,
include the new IRA account number and custodian's address.
With a rollover to a new 401(k) plan,
check to see if your new plan accepts rollovers (not all plans do) and then make sure you
have the correct information about the trustee who will accept your money.
Another way to ensure a smooth
rollover is to make a trustee-to-trustee transfer. That way, the money goes directly from
one tax-deferred account to another and there are no potential tax consequences for you.
In the unlikely event that the money
is sent directly to you, you will have a 60-day period in which to place the money in a
new tax-deferred account. If you don't, the IRS will assume that you have permanently
withdrawn your money and you will owe an early withdrawal penalty and taxes on the
distribution. The penalty will apply only if you are younger than 59ý.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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