The 3rd Decade Podcast

Rollover IRAs

September 08, 2021 3rd Decade Episode 29
The 3rd Decade Podcast
Rollover IRAs
Show Notes Transcript

In this episode, Scott discusses Rollover IRAs: what they are, when they're relevant, & their benefits. 
Common reasons for establishing a Rollover IRA are:

  • Consolidating where your accounts are held
  • Lower fees than 401ks
  • More control over your money

If you have an old retirement account from a previous job, you may want to consider this for yourself. Scott points out some of the things to keep on your radar, how to start this process, and the benefits of doing a "direct transfer" to a Rollover account to avoid any potential penalties or taxes. 

Scott Bennett:

How's it going everyone, my name is Scott Bennett, and thank you for listening to the 3rd Decade podcast today. We're gonna be talking about rollover IRAs. Rollovers can be one of the more confusing things that participants do when completing their financial plans. And we get quite a lot of questions on the mechanics and how to do that. I t can also seem a little bit intimidating, so we wanted to release a really quick podcast that's hopefully helpful and answer some of the questions that we receive quite a lot. So the first thing that we wanted to address is, what is a rollover IRA? Basically, you are rolling over money from an old employer sponsered plan, l ike a 4 01k, a 403B, a 457, even sometimes a pension plan. Into your own personal IRA or individual retirement account. IRA stands for individual retirement accounts. So your employer-sponsored plans like your 4 01k, those are controlled by your employer. Or in this case for rollovers, your old employer had set this plan up and it's based on the rules and things that they put into place of the plan, who your plan, administrator's going to be, who your custodian's going to be, who your investment firm's going to be. What are your choices? And a big reason that people do rollovers is to get that personal, control over their assets. I left this old employer. There's no reason for it to be at this plan anymore. So who should be thinking about doing a rollover? I said before, somebody who left their old job and, that's, that's really the first thing there are, this is a little bit confusing, but it's important cuz I don't wanna put any misinformation out there. You can do what's called in-service distributions a nd some 4 01k plans or employer-sponsored plans. Which means you can still be enrolled in the plan and employed by that firm. And they've allowed for you to take the money o ut o f that plan while you're still employed with them. Those are really rare though. I just wanted to make a note there because I'm gonna be talking of mostly for the people who have left their old job left an employer-sponsored plan and they just have that money sitting there. So we wanted to give an example, we talk to 3rd Decaders all the time in our mentor meetings. We ask each 3rd Decader to break down the different accounts that they have. And a lot of times we'll hear,"I have four different 401k's" and that's because that person's been through a few different jobs. Or"I have a 401k and a 403bB and a 457 all from old employers." W ell, that's okay, it's not necessarily the end of the world, but for prudent financial planning, it's probably a good idea to consolidate those and take control over them y ourself. A lot of times when, when we talk to 3rd Decaders, they say,"I don't even know how to log into that account" or"I don't have any idea what that's invested in." If you're keeping track of all of those old accounts and stuff. Okay. Maybe it's, it's fine to lead them there. But for the vast majority of people, we talk to, it makes a lot of sense to do a rollover, so you can have control over those assets, you know, where they are and you just have a lot more organization based around your personal finances. Another reason to think about doing a rollover IRA is a lot of times you can save on fees and expenses. So with the employer sponsored plan, there are usually a little bit more expenses associated with those. Now this isn't always the case, but by opening up a rollover IRA, you have a better chance of saving on fees and expenses. So if you look over your plan documents from your old employer sponsored plan, and you're seeing that there's management fees and different fees associated with being in that plan, and you can compare those, the fees associated with opening up a rollover IRA. A lot of time that rollover IRA is gonna be cheaper and you're gonna be open to more fund options. So as I touched on before in an employer-sponsored plan, you're kind of at the mercy of whatever that plan selected as their available funds. And sometimes that's fine because they have really good fund options available. Other times I've seen some pretty terrible employer-sponsored plans in terms of the amount of fees associated with their fund options available. When I look at some employer sponsored plan, I'm always shocked to see some that, you know, don't even offer a fund that's under 1% in terms of an expense ratio. When you can easily get funds out there that are indexed approached for 0.05%. So another reason to have a Rollover IRA is that it opens more funds that would also potentially save you on fees. So those are some of the reasons to do it. What are the things to look out for when doing a rollover IRA? So you wanna make sure you do what's called a direct transfer rollover. If I say one thing in this entire podcast, that is what you should hear a direct transfer rollover. So what does that mean? Let's back up a little bit. You have an employer-sponsored plan and I'm gonna use a 401k as an example, you have left that employer and you're no longer working with them. You might even have another 401k open at your new employer and you're working. And this could be somebody that you left working for a few years ago or even longer, or it could be somebody you left working last month, but you're no longer employed by that person. You don't plan to go back to working for that person or that that company, that money that you had in your 401k is probably invested. It should be invested in whatever you left it invested in, and they'll kinda leave it in there and leave it alone. You can't contribute to it anymore because you're no longer employed for them, but it's still invested in whatever you left it invested in. Now you want to open up a rollover IRA for all of those reasons I just went over. So the first step is to contact an institution that you can open up this rollover IRA; a Charles Schwab, a Vanguard, a Fidelity. Those are the big ones that a lot of our participants use. And if you already have, have a Roth IRA or an IRA open at an institution, you can use that same one. So you call'em you say,"Hey, I need to open up a rollover IRA." You can do it online very easily as well. Have that new account account opened first, if you already have an IRA open, great, you can that rollover money can be put into that IRA, but direct transfer rollover again, as I said, very, very important. What this means is your old 401k is sending that money to your new account, to the new IRA or the already established IRA, the rollover and not to you. And that's a big, big distinction because if that old plan says, I'm sending this to you, they're obligated to take out 20% withholding, 20% taxes on that money. So let's say you, have$10,000 in that account and that 401k and you, you don't do a direct transfer rollover. You're gonna get a check from for$8,000 because that old plan is withholding 20% to send to the IRS for tax purposes. Now, if you do a direct transfer rollover, you have$10,000 in that account, you're gonna get$10,000 into your next IRA. Now you do have, let's say worst case scenario. You get that check sent directly to you. Again, we use a$10,000 example.$10,000 is sent or$8,000 instead of$10,000 is sent directly to you. You do have 60 days to deposit that money into an IRA. So the IRS won't look at it as a distribution. However, there is another hurdle to get over if this happens. So the$10,000 example, if$10,000, you get sent a check for$8,000 because the old employer plan did not send it as a direct transfer rollover. They sent it directly to you. What you then have to do is deposit, not just that$8,000 into a new IRA before 60 days, you also have to deposit the additional$2,000 that was withheld. So the full amount of$10,000 has to be deposited into an IRA. And if not, let's just say you deposited that$8,000. The IRS is gonna look at that as a distribution and you'll be hit with the 10% early distribution penalty on that money as well. Not something you wanna do. So again, do a direct transfer rollover. Now, some people have Roth 401ks. For you it's the same thing. You can do a Roth 401k into a Roth IRA. You might have both. You might have both Roth money and traditional 401k money in your 401k. You would open up two separate accounts if have no Roth IRA or no IRA, you'd open up a Roth IRA and a rollover IRA or a traditional IRA. And that money would be transferred into those accounts. Another thing to look out for when doing a rollover is that the money, a lot of times is being sent to your institution in cash, right? So, it might have been invested and might have been invested, okay. In your in your old plan. But when that's sent over to your new institution, that money is going to be in cash most of the time. So it's up to you to know when that comes in and reinvest it, how you wanna invest it based on your financial plan. You definitely don't want that money just sitting there in cash that, that defeats the purpose. If you're not gonna reinvest that money, I'd rather it sit in the old plan, probably. So you need to look out and know when that money's coming in. When you see it, reinvest it into the market. Your goal is long term growth, if you have a long time horizon, as a lot of the 3rd Decaders do. Do watch out because the funds will come in as cash. So how do you do this? A lot of times when you open up a rollover IRA, or even if you have an IRA or a Roth IRA, at an institution already, you can call that institution and say,"Hey, I'm looking to do a rollover. I need some help." And they have people dedicated to doing this because you're putting more money into their institution. It's a good thing for them as a business, as well as yourself, you now have more control over it. If for some reason you don't get that much help and you're still going,"I have no idea how to do this." Really. What you wanna do is you wanna reach out to your old employer's plan administrator, who was sending you the statements when you were getting 401k statements, or who did you have a login to reach out to them? And you say,"Hey, I have an account with you all. I'm looking to do a rollover. How do I do that?" They should be able to send you all the necessary paperwork that you'll have to fill out. Now, there is some paperwork associated with it. On that paperwork is where you're gonna mark that direct transfer, rollover. And they'll ask you, do you wanna do a direct transfer? That answer is yes. And you need to write as well, the account that you want that direct transfer to go to. So have that account number ready, have all that information. Ready again, your new custodian, that you work with, that you open up the account at, should be able to help you out with that last thing. As a, as a very, almost technical aside, if you have a traditional 401k and you just do a rollover into a, into a traditional IRA, meaning tax deferred, you weren't taxed on that money when it went in, you're not taxed on the growth now. And, and then you're tax. When you, when you withdraw the money in retirement, if that's the case, everything I said applies, if it's the case that you have a traditional, 401k, and you w anna put that money, let's say into a Roth IRA. So it's traditional money tax deferred money that you wanna convert into Roth money. You can do that as well. However, you have to pay taxes on the full amount that you convert. So it is a good decision for some people. It's a pretty technical decision. I would talk to a CPA or somebody like that before doing that, because you could have a hefty tax bill at the end of the year, if you're transferring a bunch of money from a tax deferred to account to a Roth account. So all in all rollover IRAs are a really good idea. If you have a bunch of accounts, or if you have an old employer account that you're saying, oh, the fees and stuff for this are too much, or I, I never look at it, or it would be much easier for it to be in with my other retirement accounts. If you are in control over that money, you can say, oh, I would much rather invest in this passive index mutual fund that I can get for a lot cheaper and a rollover IRA than I could in my old employer plan. That's when to do a rollover IRA. Again, I'm gonna finish with this, make sure that it is a direct transfer roll. They can sometimes be called tr ustee t o trustee. Basically, you want them sending the check to the other institution and not to you yourself. So don't be too intimidated by it. There's lots of stuff online to walk you through this. Again, if you choose to do a rollover, the institution that you open it up at should be able to help you as well. Or if you have a 3rd Decade mentor, you can reach out to them and they can give you some tips and stuff for how to do it as well. I hop e th is was helpful to anybody thinking about this as a decision. We will talk to you again soon. Thanks.