401k rollover versus withdraw

An early withdrawal from ANY traditional IRA, regardless of the funding source, is subject to a 10% penalty on the taxable portion of the distribution unless an exception applies. The taxable portion of the distribution is of course subject to income tax as well, but that would be true even if it wasn't an early withdrawal. (If you've never made any non-deductible IRA contributions the entire distribution will always be taxable).

See IRS Publication 590.

Also note that if one of the 401(k) plans in question is at your most recent employer and you are over *55*, then depending on the circumstances of your leaving and how long it's been since you left, you might be eligible for special 401(k) treatment that allows you to make 401(k) withdrawals without penalty.

Does the new employer have a 401(k)? Benefit of 401(k) rollover - money can be borrowed, if income gets too high for traditional IRA, you can still deposit and convert to roth, or just go Roth. Benefit of IRA - you can slowly convert to Roth, just converting enough to fill current bracket each year. A nice way to take advantage of this opportunity.

Another thing to consider is that it is possible (although I know of know such cases presently) that IRA's will count against you as being assets that preclude eligibility in some future federal program (e.g. healthcare credits, if those ever get implemented). To the extent IRA's and 401(k)'s might get treated differently, the

The above is speculative, but it is something to consider.

Steve

To clarify Rich's statement, if you separated from service with your employer and were at least age 55 during the year of separation (age 50 if employed as a public service officer), the

A couple of things not mentioned in responses (or I missed them):

Make sure you do a direct transfer from the 401(k) to the IRA without taking possession of the money. Otherwise 20% of the gross will be withheld for income tax.

If you have appreciated employer stock in a 401(k) it may be to your advantage to take a distribution of that stock rather than rolling it over. See the discussion of Net Unrealized Appreciation in IRS Publication 575, which is the general reference for 401(k) information. Pub 590 covers IRAs.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Thanks for all the replies.

This is what I understand from the replies -

It looks like there is no difference in terms of early withdrawal penalty and tax between 401k and ira.

The actual differences are - can take a loan in 401k but not in ira - can convert to roth in ira (but maybe also in 401k)

I am not too concerned about either of above at the moment. I am also not interested in taking money out for spending.

My main concern was lack of control in 401k and lack of investment choices and ability to bail in time (in a related note I lost money on

I am no longer a salaried employee so no 401k anymore. I guess this only makes a difference in terms of rolling over to another employer, which I am not interested in anyway.

One followup question I have is - since I want to roll over two different 401k, should I be creating two ira accounts or one. I'd prefer one. Is there any reason to do otherwise?

-Antony

My main concern is lack of control and investment choices in 401k, so I guess I'll have to take this risk.

-Antony

The only time I've found multiple IRAs to make sense is if: (a) there are proprietary mutual funds you want, only available through the fund company, else a high fee. (b) you'd like separate accounts going to different beneficiaries on your death (c) you convert to multiple Roth accounts to then recharacterize the losers after a year

(likely a few more)

In your case, these may not apply. You can always create more IRA accounts when you wish. For now, I'd just do the transfer to one.

If you want to be able to have more investment choices, one possibility may be to set up a self-directed IRA. That's a big topic and I am certainly not an expert in any of this. But my understanding is that with a self-directed IRA you can choose to invest in a variety of ways that are not available in traditional IRA accounts -- such as real estate, tax lien certificates, private lending to real estate investors secured by a 1st mortgage, etc. I know it can be expensive to properly set up a self-directed IRA, and there are a lot of rules that need to be carefully followed. You could try doing a Google search for "self-directed IRA" to get more of an idea of what they are and how they work.

snipped

You should also be aware that the premature distribution rules are a bit different for 401Ks. If you have an IRA you have to be 59 1/2 to get the money and pay NO penalty. But for a 401K you can be 55 and Separated From Service and get the money penalty free. I ALWAYS look at the age of my client and discuss their future plans before making any recommendation to take or leave the money in their 401K plan.

So if you're 40 and working at a good stable job, I might suggest that moving it is OK.

But if you're 54, unemployed and THINK you MIGHT need the money to buy food in the next year or two I'd suggest you leave it where it is.

Also, do keep in mind that you can always move the money INSIDE the 401K plan - just park it all in cash or bonds and factor that in with the rest of your portfolio to make sure you're diversified.

Gene E. Utterback, EA, RFC, ABA

Careful, Gene.

"Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55"

If you were 54 still at the end of separation year, you cannot withdraw penalty free at 55. When I re-read your sentence above, I'm afraid it implies otherwise.

Above line is from IRS site

I have had a number of 401(k)'s that I have converted to IRA's. I agree that the control and variety of investment choices are paramount.

In some cases, a 401(k) may have superior investment choices. For example, IRA's pretty much never offer GIC's (Guaranteed Income Certificates), which at least in theory guarantee no loss of principal and generally pay higher rates than alternatives such as money market funds. Also, in some cases you may get better choices in a 401(k). For example, my employer offers Vanguard Institutional funds, which have lower expenses than their regular funds. (However, while I wouldn't call this rare, it's also not that common. I work for a company rated "Best Company To Work For In The USA" and one of the reasons is that they do stuff like that, like making sure our 401(k) fees are low.)

I would deflintely keep the money segregated in a "Rollover IRA" and not comingle it with any other funds that did not come from an employer plan. At one time, these were the only funds that could be returned to an employer plan.

In most cases, if it becomes important, you can open a self-employed

Bottom line, it's not a crucial decision, I would convert if I were you (as I did in my own case), and the consequences of a wrong decision are likely to be slight.

Why? As you noted, at one time "tainting" the IRA with contributions meant you couldn't roll from it into an employer plan, but no longer. I can't think of any other reason why you'd need to segregate it.

Phil Marti VITA/TCE Volunteer Clarksburg, MD

Aren't there some bankruptcy protection differences?

IIRC an IRA account that has never received anything but qualified plan rollovers enjoys a higher bankruptcy exemption than one that has received even $1 of annual contributions.

My apologies for not being clearer.

Gene E. Utterback, EA, RFC, ABA

For bankruptcy protection, a Rollover IRA (Only contains rollover funds from a qualified plan) is fully protected. All other IRAs have $1,000,000 of protection. If there is no bankruptcy filing, then state law will determine how much a creditor can go after. Here is a link to a state chart that was created in 2007. If someone has access to more current data, please post.

How do "solo" 401(k) plans figure into this? For tax purposes they are considered qualified plans. But what about for bankruptcy purposes? If you have a rollover IRA account funded from "normal"

Conversely, what happens if you roll an IRA (possibly containing contributory funds) into a solo 401(k) and then down the road roll it back into a new rollover IRA?

I dimly recall reading (perhaps in this very group! :) that "solo"

A Solo 401(k) is governed by Section 401, is a qualified employer plan covered by ERISA. I see no reason why a Rollover IRA that contains a rollover from a Solo 401(k) would be treated any differently than other Rollover IRAs for bankruptcy protection. I see nothing in BAPCA (PL

Before I answer this, having had to reread a summary of BAPCA I discovered that:

1. SEP & Simple IRAs are treated as QRPs for bankruptcy protection. I.e., full protection.
2. Traditional & Roth IRAs are limited to M. However, Section 224 of the Act says that if you rollover amounts from a QRP either directly or using the 60 day rule into an IRA, those amounts do not lose their protection in bankruptcy. I.e., the m limitation does not apply to the rollover amount. There is nothing in BAPCA that says you have to establish a separate account for those funds. I have not checked to see if there is any guidance on this subject.

So... back to the question: I don't know. Without knowing whether there is any guidance, I would guess that any amount in an IRA that can be traced to a QRP is fully protected. Amounts that can not be traced to a QRP would be protected up to the $1M limitation. It seems to me, that for tracing purposes, the easiest way to do that is to set up a Rollover IRA and don't taint it with IRA contributions or IRA rollovers.

Lastly, section 225 of BAPCA has the rules for CESAs and 529 Plans.

Prior to BAPCA (PL 109-8) a plan that covered only the business owner was not fully protected. BAPCA changed that.