In-Service Rollovers: Unleashing Hidden Value in Your Retirement
At Farther Wealth, we believe that retirement planning is an ongoing, dynamic process filled with critical decisions—one of the most important responsibilities being the ongoing management of your retirement accounts and maximizing opportunities as you approach retirement. For many of our clients, who often work at Fortune 500 companies, their employment package offers substantial benefits for wealth building and tax savings.
One strategy that is often underutilized but can potentially unlock hidden value in your retirement accounts is something called an “in-service 401(k) rollover.” As we delve into the intricacies of this approach, we uncover exactly what it is, the eligibility rules you need to be aware of, and the pros and cons of this potential option. Regardless of where you are in your career, understanding in-service rollovers can be a substantial asset in your financial strategy toolkit.
Understanding In-Service 401(k) Rollovers
An in-service 401(k) rollover permits the transfer of assets from your existing 401(k) plan to an IRA while you’re still employed at your current job, opening up avenues for potentially better investment and savings strategies. This transition can be executed through two main avenues: direct and indirect rollovers.
In a direct rollover, the funds in your 401(k) are moved directly to an IRA without you ever touching the money; this procedure safeguards your savings from immediate taxation and penalties. Conversely, an indirect rollover involves receiving the funds from your 401(k) to deposit into a personal account; you then have a 60-day window to transfer these assets into an IRA, failing which could lead to taxes and penalties.
While this strategy is favored for offering more investment opportunities and potentially lower fees compared to 401(k) plans, it necessitates a careful consideration of tax implications. Rolling over to a traditional IRA doesn’t trigger a tax event, whereas choosing a Roth IRA, which accepts only post-tax funds, does incur taxes. To leverage the benefits fully and avoid tax ramifications, it’s vital to conduct a seamless transfer, keeping in line with the necessary regulatory mandates and timelines.
Eligibility Criteria
Determining your eligibility for an in-service 401(k) rollover is the initial step in this process, and it comes with its set of prerequisites that can be fairly stringent. It is important to note that not all 401(k) plans offer in-service rollovers, necessitating a consultation with your plan custodian to ascertain if it’s a feasible option for you.
Specific eligibility criteria may apply, including but not limited to being at least 59½ years old, having a 401(k) account that has been active for a minimum of two to five years, or having reached the retirement age defined by your plan. Other situations that might render you eligible include account termination and experiencing a disability. Post-rollover, guidelines regarding the resumption of your 401(k) vary between employers, with some necessitating a waiting period before you can begin contributing again. It is imperative to comprehend the full scope of your plan’s stipulations to navigate this process effectively.
Benefits of Opting for an In-Service 401(k) Rollover
Typically, 401(k) plans offer a restrained palette of investment options, limiting your ability to diversify your portfolio according to your preferences and risk tolerance. In contrast, investing in individual retirement accounts (IRAs) through an in-service rollover empowers you with a rich array of investment options. It broadens your access to various assets including but not limited to individual stocks and bonds, mutual funds, real estate investment trusts, and even some alternative investments, allowing for a finely tuned approach to asset allocation.
Moreover, this strategy often leads to a pathway adorned with potentially lower fees, a factor that can significantly influence your overall retirement savings in the long run. Transferring your assets to an IRA might offer a more cost-effective solution, steering you clear from the often higher administrative and management fees associated with 401(k) plans. Being able to focus on what you can control with your investments (like fees and investment options) can give you a greater sense of ownership and confidence in your plan and your future retirement success.
Drawbacks to Consider
While the in-service 401(k) rollover brings enticing opportunities, it is accompanied by certain caveats that warrant careful consideration. One significant downside is the limited legal protections offered to IRAs in comparison to 401(k) plans. 401(k) plans are shielded by the comprehensive federal protection provided by the Employee Retirement Income Security Act (ERISA). This law ensures your assets are generally safeguarded against creditors in bankruptcy situations, except for a few specific circumstances, such as certain IRS levies and domestic relations orders.
Conversely, IRAs have a capped federal protection limit set at $1,362,800 (adjustable every three years for inflation, as of 2022) during bankruptcy. Outside bankruptcy scenarios, protection is subject to state laws and can vary significantly, potentially offering lesser security than 401(k) plans.
Furthermore, unlike 401(k)s, IRAs do not permit borrowing from the account, a feature that might come in handy in pressing financial circumstances. The age parameter for penalty-free withdrawals is another area where IRAs fall short; while 401(k) holders can initiate penalty-free withdrawals from the age of 55 under specific conditions, IRA holders must wait until they are 59½ to avoid the 10% IRS penalty on early distributions.
Is an In-Service Rollover Right for You?
Determining whether an in-service rollover is the right move for your financial future can be a complex decision involving many nuanced factors. However, you do not have to navigate this and other critical decisions alone. At Farther, our team is here to help illuminate the best path forward that suits your individual needs and financial aspirations. That might include an in-service rollover, and it might not. Either way, we will work to give you clarity on what you need to do moving forward. To get in touch, please call 510-335-8808 or email michael.lee@farther.com.
