All Rollovers Aren't the Same -- 401ks Are Different Than IRAs
One common complaint we hear from readers is how long and complicated the process of withdrawing or rolling money out of their 401k plan can be, especially when compared to making an IRA rollover or withdrawal.
Their observations are right on the mark -- 401k withdrawals and rollovers are more intricate than with IRAs. That's because the 401k rules were deliberately designed to make it more difficult for anyone to access your money, including creditors. That's true whether the creditors are yours or your employer's.
While there isn't any magic bullet to make a 401k withdrawal or rollover go more quickly, understanding the rules about how they work will help you develop a strategy to make your rollover as smooth as possible.
Asset Ownership Differences
Rollover procedures are different because assets are held differently in a 401k plan than in an IRA. "The money you have in a 401k is held in a trust for your benefit," said Ted Benna, president of the 401k Association. "With an IRA, the ownership resides with you."
Indeed, IRA assets are your property and you can direct your IRA custodian to maneuver your assets as you wish. Typically, all that's required is your signature to authorize a change in investments, or to make an account withdrawal or rollover.
Because your employer sponsors the 401k plan, the assets are not actually your property, but instead are owned by the plan. Federal law requires that your contributions be held in a trust and administered by a trustee, who is charged with managing the assets on your behalf.
The trust holds your 401k money apart from your employer's general assets. That means, for example, that your employer can't use them as collateral for a business loan and the money can't be seized by creditors if your employer goes bankrupt
The drawback to these protections is that there has to be an additional level of administrative oversight. That's why 401k money is tougher to get than IRA money.
In order to get your money from your 401k plan for a rollover, you need to have "a benefit event," as it is known in the human resources industry. That usually means you retire, reach age 59½, or otherwise leave your job.
When the benefit event occurs, you'll need to tell your employer how much you are taking and where you want the money to go by filling out a 401k-election form. Common options include lump-sum distributions, regular periodic distributions or rolling the money to another 401k plan or an IRA.
After submitting this paperwork to your employer, it's processed and a formal notification is made to the plan trustee (often a high official at your firm) that a distribution can be made. The trustee, in turn, forwards the distribution notice to the firm that administers the plan.
"Before we can release the money, we must receive notification from the employer (or trustee)," said Dean Schmitz, assistant manager of sales with Principal Connection, a business unit of the Principal Financial Group.
At a minimum you should expect a 401k withdrawal to take two or three weeks regardless of where the money will end up, industry experts say.
A slow rollover tends to be the exception rather than the rule, said George Diones, vice president of the client management group with Diversified Investment Advisors. After all, many employers are as eager to give you your money as you are to remove it from their plan, he added. One common reason employers want you to close your account after leaving is to reduce the administrative expenses the plan pays.
With an IRA rollover, you only need to notify your custodian that you are making a withdrawal or rollover. And sometimes (as explained below) you don't even need to do that.
There are two ways to move money from one 401k to another or to an IRA. Either the money moves via a direct transfer or the money is sent to you and you move the money to the new account. For this example, let's assume that you're using the direct transfer method. In other words, the money moves directly from an IRA to an IRA or a 401k to an IRA, without you touching it.
This process is known as a direct rollover or trustee-to-trustee transfer. When you move your money this way, you never have to worry about the tax consequences of your transfer.
We will take a look at two basic transactions, moving money out of a 401k to some other tax protected account such as an IRA or another tax-qualified plan such as another 401k, and moving money between IRAs.
If you've ever made an IRA-to-IRA rollover, you know that the process is relatively simple. Actually, your new IRA custodian will often take care of the entire transaction for you. You fill out a form giving the custodian permission to transfer the assets from your old IRA, and the money is usually moved within a week or two.
That's half as much paperwork as you'll have to do for a 401k rollover. For those, you need to fill out an election form with your old employer and then fill out another set of paperwork with the firm accepting your rollover. You should expect your 401k rollover to take a minimum of two weeks and possibly three. Currently, it takes the Principal two weeks to process a 401k payment once it receives the paperwork from the employer, Schmitz said.
Some 401k-plan providers will help you set up an IRA with their company, because they want to keep your money invested in their funds. They will also help you fill out the 401k to IRA rollover paperwork. This may not be a bad strategy if you like the investment options currently available to you.
Smooth Rollover Strategies
One key to a smooth and timely 401k or IRA rollover is filling out all the paperwork correctly and completely.
"The participant has the responsibility to read the papers and check them off," said Trisha Brambley, president of Resources for Retirement Plans Inc. "If you mess up, the former employer will issue you a check ... and then it's a big mess."
Make sure you have a new IRA account set up to receive your money or a new 401k open at your new employer before you initiate the rollover. This way, you'll know the appropriate account numbers and addresses to receive your money.
With a 401k rollover, be sure you have correctly filled out the election form. If you are rolling your money to an IRA, include the new IRA account number and custodian's address.
With a rollover to a new 401k plan, check to see if your new plan accepts rollovers (not all plans do) and then make sure you have the correct information about the trustee who will accept your money.
Another way to ensure a smooth rollover is to make a trustee-to-trustee transfer. That way, the money goes directly from one tax-deferred account to another and there are no potential tax consequences for you.
In the unlikely event that the money is sent directly to you, you will have a 60-day period in which to place the money in a new tax-deferred account. If you don't, the IRS will assume that you have permanently withdrawn your money and you will owe an early withdrawal penalty and taxes on the distribution. The penalty will apply only if you are younger than 59½.
This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.