Old 401k, rollover? To what?

I always like to have control of my money. As a result, I suggest doing a rollover into a self-directed IRA. From there, look at low cost funds that track major indexes. Avoid programs where you give up control, like an annuity or whole life insurance.

-john-

I agree with John's reply, the Roll over to IRA.

An annuity is a tax deferred vehicle, so is an IRA. The expenses associated with the annuity should provide you tax deferral you otherwise would not have. Putting an annuity into an IRA or for that matter, putting Tax Free Muni bonds into an IRA, is not a wise thing to do.

At 40, as much of your return in the next 25 years will come from the fees you avoid as from the asset allocation you choose. I pull the number 2% out of my er, hat, to tell you that you may choose a planner who will charge 1% and then put you into a fund charging 1% or more in its own expenses. Over 25 years you will have lost half your account to the fees. Think about this and choose wisely. JOE

So you are using a tax deferred vehicle inside another tax deferred vehicle?

How long have you had this 401K, and what is it invested in?

Start by getting some education before you make any moves.

It's a very common thing for folks to do, and, yes, it's usually a mistake. But VAs are far from obvious devices and folks are often sold them without understanding what they are or why they should have them. (It may be possible that there is a case to be made for a VA in an IRA rollover, if the case can be made for the VA at all - on the basis of wanting some of the riders/guarantees. But it's very unlikely that this was really the situation here).

To the OP - several of us here highly recommend Eric Tyson's book Personal Finance For Dummies. Don't be put off by the title or bright yellow cover. It's a very solid book, a pretty easy read, has some decent worksheets, and I can't think of a better starting point to help you find a path to get over the "getting antsy" stuff. It's not for the sophisticated investor or financial engineer, and it won't tell you how to read a balance sheet or evaluate an individual stock. But truthfully, most folks don't need that stuff anyway. What it will do is help you navigate the forest of 401k, IRA, VA and other insurance products, etc.

Mutual Funds for Dummies is also good.

My own thought is the OP should consider rolling the 401k into an IRA, and investing in an index fund like the Vanguard Total Market Return fund. The key being low costs, and performance broadly in line with the market. In 20 years time, at an 8% pa return (not an unreasonable expectation for a broad stock market index fund), the OP would have something like 4.7 times his/her money.

Whereas if invested in a cash or bond fund returning 4.5% (again not unreasonable) he/she would have 2.4 times his original investment.

Regardng this - unless you have very good reasons for that VA, it may actually be worth, if necessary, paying termination fees and getting out of it. VAs can have ongoing expenses of 2% or more (usually paying for guarantees that you may have no need for). Even if you have to pay 8% to get out of it, you'll recoup that cost pretty quickly in low-expense no-load mutual funds which otherwise invest similarly to whatever you've chosen inside the VA (assuming such choices themselves were made well).

Tyson really is wonderful, however, I'd definitely start with PersFin. MF for Dummies is kind of a big expansion of a chapter or two of PersFin and if the OP wants to learn more about them - after getting a handle on his bigger picture - I'd certainly recommend MF for Dummies or even Investmenting For Dummies.

I'd certainly want to talk about rolling the 401k into an IRA for a variety of reasons. As far as what he invests the IRA itself into, though, even that can wait until he gets a better handle on the current situation and in the meantime, leaving it in cash (ie. Vanguard's Federal MMF is paying > 5% right now) is not a big deal.

20 years is a long time. I should hope it won't take him that long to read a book or two and figure out what to do! (ie. probably not leave it in cash for the long run)

I'm surprised no one has mentioned Roth conversion. IMO, the best thing about doing an IRA rollover is the subsequent Roth conversion. There are all sorts of benefits to doing the Roth conversion:

1) Roth's are "denser" than traditional IRAs, so you'll effectively be tax sheltering more money (assuming you don't dip in to your IRA to pay the tax bill). 2) After 5 years, you can withdraw the converted amount without penalty. 3) Roth distributions don't affect the tax on Social Security benefits. 4) Roth's aren't subject to required minimum distributions.

--Bill

Your post was short and sweet, I left it intact, as my question is brief; Does (2) provide an exception to 72(t)?

I manage the money of a 48 year old who isn't working. Each year I've converted enough IRA to Roth to stay in the zero bracket. In two years she will have depleted her post-tax money, and would have to draw from either the Roth or regular IRA. (2) tells me she can withdraw any Roth that's aged 5 years, tax free, and continue to shift from IRA, i.e. a conversion from IRA, but a withdrawal of old Roth money. This would let us avoid any 72(t) calculations. Do you see an issue with my reasoning? JOE

Yes, that should be fine.

Also note that the five year rule isn't EXACTLY a five year rule. For example, if you did a Roth conversion on 12/31/2000, you can withdraw the money on 1/1/2005. In fact, in the case of Roth contributions, the "five-year" period can actually be less than 4 years. Suppose you made a CY '98 Roth contribution on 4/15/99. Your "five-year" period is then up on 1/1/03.

Fool.com has a good article about this:

Discussion of the "five-year" rule is under "Roth III: Distributions" and early withdrawals are covered in "Roth IV: Early W/Ds".

--Bill

PUB 590 says that there is a separate 5 year period for *each* conversion. Also, you still have to be over 59 1/2 to avoid the penalty.

I don't believe this is correct. The 59.5 age rule only applies to earnings. So if you're only withdrawing contributions or conversions (after the 5-year rule), the 59.5 age rule does not apply. After all, you've already paid taxes on contributions and conversions.

--Bill

I keep asking for someone to point me to an IRS publication or instruction that says that but all I get is pointers to non-IRS web sites that say that. I can find nothing on the IRS FAC's, Topic letters or PUB's that say anything about the penalty only applying to earnings. The IRS says: "To discourage the use of pension funds for purposes other than normal retirement, the law imposes an additional 10% tax on certain early distributions of these funds. Early distributions are those you receive from a qualified retirement plan or deferred annuity contract before reaching age 59 1/2. "

I have always believed that this is to prevent you from removing a contribution prior to retirement age once it had been made.

They DO say that you are not TAXED on removing contributions that you have already paid tax on but it seems clear in PUB 590 that you are subject to the 10% penalty on any non-qualified distribution (and being under 59 1/2 makes it unqualified except for certain exceptions which don't apply here). The way I read it the 5 year rule for conversions is an ADDITIONAL hurdle you have to jump over, it doesn't eliminate the other requirements.

The only place that the 5-year period on conversions is mentioned at all is on page 64 or chapter 2 of PUB 590 and it only says what happens if a distribution is taken BEFORE the 5-year period is over. It says NOTHING at all about treating the distribution from a conversion any different AFTER the 5 years has passed than any other distribution unless I am really missing something.

I realize the the PUB's are not always perfect and the actual code (law) may say otherwise, but I would think that if that is the case that there would be something about it somewhere on the IRS site since this seems rather basic.

Okay, go back to the ultimate source. Where does the 10% penalty come from? Section 72 of the IRC. More specifically, the oft-cited 26 USC 72(t). Section 72(t)(1) gives the clear statement:

"If any tapayer receives [an IRA or pension distribution] the taxpayer's tax ... in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is INCLUDIBLE IN GROSS INCOME." (That is, taxable.)

So, you may be wondering, then why is a distribution from a conversion in under 5 years subject to a 10% tax? Fair question. Originally it wasn't. Congress fixed this later. That's why the conversion rules are so convoluted and appear grafted on after the fact.

That's why you have Section 408A(d)(3)(F): "Special rule for applying section 72

"(i) In general. If - (I) any portion of a distribution from a Roth IRA is properly allocable to a qualified rollover contribution described in this paragraph [i.e. Roth conversions]; and (II) such distribution is made within [5 years of conversion], then section 72(t) shall be applied as if such portion were INCLUDIBLE IN GROSS INCOME."

So there you have it - the general rule is: distribution not taxed, then no penalty (Section 72). But sub-5 year conversion withdrawals are subject to Section 72(t) 10% penalty as if they were taxed.

Mark Freeland snipped-for-privacy@sbcglobal.net

And they had to fix it because people realized it was a way to get a penalty-free early withdrawal from a trad IRA -- do a Roth conversion and then immediately withdraw it from the Roth. Presto -- no 10% early-withdrawal penalty. Once this little trick appeared in the WSJ, Congress had no choice but to plug the hole.