Rolling 401(k) into IRA gives flexibility
More than 40 percent of assets in 401(k) plans owned by workers who left their jobs in the first quarter of 2008 were with the former employers a year later, according to an analysis by Charles Schwab. The remaining assets were invested in an individual retirement account, rolled into a new employer’s plan or cashed out.
Leaving your 401(k) with a former employer is vastly better than cashing it out, which will trigger taxes and penalties. But here are some reasons you should consider rolling your money into an IRA:
You’re unemployed and need to buy health insurance./b If you’re out of work, you can take penalty-free withdrawals to pay premiums. To qualify, you generally must have received unemployment benefits for at least 12 consecutive weeks. The rule also applies to premiums paid under COBRA, a federal law that allows you to continue your former employer’s coverage up to 18 months, says Bob Scharin, senior tax analyst for Thomson Reuters.
b You’re considering buying a home./b If you’re a first-time buyer, you can withdraw up to $10,000 penalty-free toward the purchase of a principal residence. The law defines a first-time buyer as someone who hasn’t owned a principal residence for two years before the purchase.
b You need money for college./b You can take penalty-free withdrawals to pay college expenses for you, your spouse, your children or your grandchildren.
b You’re considering early retirement./b Ordinarily, if you take withdrawals from your tax-deferred retirement savings before age 591/2, you pay a 10 percent penalty. You can avoid this, however, by taking advantage of the substantially equal periodic payments rule. With it, you agree to withdraw a specific amount for five years or until you turn 591/2, whichever is longer. You’ll still owe income taxes.
Legally, there’s no prohibition against taking periodic payments from a former employer’s 401(k), but some plans limit the types of distributions you can take.
There is an important caveat for early retirees. If you’re 55 or older when you leave your job, you’re eligible to take penalty-free withdrawals from your former employer’s 401(k) plan. This option isn’t available if you roll the money over to an IRA, Scharin says.
Keep in mind, though, that this exception is limited to workers who are at least 55 when they leave their jobs. If you retire at 54, you’re not eligible, even if you wait until you’re 55 to withdraw the money.
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