There are two situations where you may have to decide what to do with the money in your employer-sponsored retirement savings plan: when you're changing jobs and when you're retiring. Weigh your options carefully. What decisions you make today with your retirement savings could have a big impact on your future.
Let's say your employer offers you a lump sum distribution of your money. You could take that check and spend it. But before you do, keep in mind that this type of distribution is generally subject to ordinary income taxes as well as a potential 10% federal tax penalty.
Another option is to think about how that money might continue to grow for you in the future. This is important because life expectancies are increasing, and you don't want your retirement savings to run out.
By rolling over your eligible distribution into a traditional IRA, you can continue to benefit from tax-deferred growth that could make a big difference in your retirement years.
If you decide to move your eligible retirement assets to an IRA, you'll want to make sure you complete the transaction in the right way. A "rollover" is a method of moving money between plans, such as from a 401(k) into a traditional IRA, without incurring ordinary income taxes and potential penalties.
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Direct Rollover—If you've decided on an IRA account, a direct or trustee-to-trustee transfer may be the easiest way to roll over the money. The check is made out to the trustee of the new account who will then invest the funds according to your directions. A financial organization such as a brokerage firm, a bank or an investment company should be able to assist you and your employer to facilitate the rollover.
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Indirect Rollover—With an indirect rollover, the check is made payable in your name. In such case, your employer must withhold 20% from your distribution. You must deposit the entire distribution into a new retirement plan within 60 days. If a timely transfer is not made, the distribution will be subject to ordinary income taxes as well as possible penalties. Note: The 20% withheld by your employer is considered part of the distribution. If this amount isn’t included in your rollover, it will be subject to ordinary income taxes as well a potential 10% federal tax penalty. However, you can cover the amount withheld from other sources and avoid potential penalties.
Only traditional IRAs, not Roth IRAs, can receive rollovers from qualified employer retirement plans. Once you've made the rollover, your earnings can continue to grow tax deferred. If you change your mind later and decide to roll the money into your new employer's plan, you can do so as long as your new employer's plan accepts rollovers.
As with any planning for retirement, you should always consult with a tax advisor.