facebook twitter instagram linkedin google youtube vimeo tumblr yelp rss email podcast phone blog search brokercheck brokercheck Play Pause
How Do I Rollover my 401(k) to an IRA Without Paying Taxes? Thumbnail

How Do I Rollover my 401(k) to an IRA Without Paying Taxes?

There are a lot of questions that come up when it comes to retirement planning. One of the most common is whether to rollover your 401(k), 403(b), or 457(b) to an IRA. This can be a difficult decision to make, especially if you're not sure what the consequences might be. 

In this article we'll explore some of the benefits and drawbacks of early 401(k) rollovers and help you select the best decision for your future. We'll also talk about some of the best investment options for retirees, and how to find a fee-only financial planner who can help with your tax planning and investment management. Read on if you want to learn about rolling over your 401(k) to minimize paying taxes. 

1. What is an early 401(k) rollover and why would I want one? 

If you're like most Americans, you probably have 401(k), 403(b), or 457(b) retirement account that you've been contributing to for years. We've discussed in a previous blog post how to minimize tax payments and hang onto more of your precious savings, as well as how to maximize contributions to your 403(b) and 457(b) plans

A rollover is simply when you transfer savings from your 401(k) account into another retirement account, such as an IRA. There are two ways to do this: a direct rollover and an indirect rollover. With an indirect rollover, the funds are first paid to you and then you have 60 days to deposit the money into your IRA. It's important to note that if you choose the indirect rollover option, you are subject to taxes and possibly penalties on the amount rolled over. With a direct rollover, the funds are transferred from your 401(k) account directly into your IRA.  

Depending on your situation, a rollover can be very beneficial in the long run. Doing this will allow you to have more control over your investments, enjoy tax-deferred growth in your traditional IRA, and have access to a wider range of investment options. Remember, it's important to work with a fee-only financial advisor to make sure you are making the best decision for your situation, but, in general, rolling over your 401(k) early is a fantastic way to secure your financial future.


2. Deciding whether to roll over to a Traditional Individual Retirement Account (IRA) or a Roth IRA 

When you reach 72, you have to take required minimum distributions (RMDs) from your traditional IRA, 401(k), 403(b), or 457(b) accounts. This is taxed as ordinary income. The rate you have to pay will depend on which marginal tax bracket you fall into at the time, and varies yearly. 

For most types of retirement accounts, if you withdraw before age 59 you will be subject to an early distribution penalty of 10%. Additionally, you have to pay taxes on the amount you withdraw. Retirement plans will withhold 20%, but the actual tax amount will be based on your existing income and your marginal tax brackets. However, if your employer allows, and you qualify for an in-service non-hardship withdrawal, you can rollover to an IRA and avoid taxes and penalties. 

With a Roth IRA, you are not required to take RMDs for the duration of your lifetime. This is a big deal because it means that your money can continue to grow tax-free because the money you put into a Roth IRA has already been taxed. Roth IRAs also offer more flexibility when it comes to estate planning. Another big advantage of rolling over to a Roth IRA is that your heirs will not have to pay taxes on the money they inherit, ensuring that your loved ones are provided for.

The benefits of rolling over your 401(k) to a Roth IRA don't stop there. You may also have the ability to do a backdoor Roth IRA contribution. This is a great way to increase your retirement savings if you're unable to contribute to a Roth IRA directly because your income is too high. 

Last but not least, rolling over to an IRA gives you the opportunity to invest in a wider range of investment options. When you have a 401(k), you're limited to the investment options offered by your employer. But when you rollover to an IRA, you can choose from a wider range of investment options, including stocks, bonds, and mutual funds.

3. Do you pay taxes on rollover IRA? What you need to know.

If you want to rollover your 401(k) to an IRA, you may need to pay taxes on the money you transfer. You can avoid paying taxes on the transfer if you do a direct rollover, where the money is transferred directly from your 401(k) account to your IRA account. However, if you do an indirect rollover, where the money is paid to you, you will be subject to taxes and penalties. Therefore, it's best to do a direct rollover if you can.

Additionally, it's important to understand the difference between a traditional IRA and a Roth IRA. With a traditional IRA, you will pay taxes on the money you withdraw in retirement. Your savings are invested on a tax-deferred basis. With a Roth IRA, you have already paid taxes on the money you contribute, so you can withdraw the money tax-free in retirement. So, to answer the question, if you roll over your pre-tax assets from a 401(k), 403(b), or 457(b) into a Traditional IRA, you will not owe taxes on the rollover transaction (they are pre-tax assets). You pay taxes on the funds if you roll over pre-tax assets into a Roth IRA.


4. Advantages and Disadvantages of Making an Early Rollover

The benefits of rolling over your 401(k) to an IRA are clear: you have more control over your money, it can grow tax-free, and you don't have to worry about the early withdrawal penalty. This can be a good idea if you're leaving your job and want to take charge of your funds, or if you're not happy with investment options in your current 401(k).

Disadvantages of rolling over your 401(k) to an IRA are that you may have to pay taxes on the transfer if your employer doesn't allow a direct rollover. Also, if your employer currently matches your 401(k) contributions, you will no longer receive this benefit if you rollover to an IRA. 

Finally, the market can be volatile, and there's always the potential for loss with any investments. Don't make financial decisions in haste, and beware of the Money Illusion! You should speak with a fee-only financial planner to get help making the best decision for your unique circumstances.


5. How do I proceed with a rollover?

 The process for rolling over your 401(k) will vary depending on your employer and financial institution. If you’re still working, they can walk you through the rollover process of making in-service non-hardship withdrawals to contribute assets to your IRA.

An early 401(k) rollover is simple to do if permitted by your employer. Some workplaces don't permit them. Some require that the employee has a certain number of years of service with the company, or is fully vested. So be sure to check your company's HR department before attempting an early rollover. A local financial planner is likely to be familiar with the retirement plan policies of major employers in your area and has experience helping local clients make their early 401(k) rollovers.

If you are retired, you will need to get a form from the same HR department to initiate the transfer. In order to do a direct transfer, you’ll need to have an IRA already set up as the 401(k) transfer form will need the account number to in which to send the proceeds. An indirect transfer will be a check sent to your home.

Speak with a fee-only financial advisor to confirm that you are making the best decision for your unique situation. With a little planning, you can be confident that your retirement savings are well taken care of.