Traditonal IRA Versus Rollover IRA, What's the Difference?

Aaron Martin - Angry Woebots - Happy
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So I recently changed jobs and also started a new 401k with my new employer. Because of this I find myself with multiple 401(k) accounts. Last time I switched jobs I didn't really check out all of my options so I just rolled over my last 401(k) into my new one. That's what I was told was the smart thing to do so that you don't have a bunch of accounts that they have to keep up with.

This time when I switched jobs I thought I should do a little more research on my options, it's a larger chunk of money so it could potentially make a big difference depending on what I do. Here's what I came up with:

Cash it out

Ugh, don't do it. First, if you're under 59.5 years old you will first pay taxes on the money, then you will pay an additional 10% tax on top of that. Part of the reason to put money into a 401(k) is to avoid taxes, so I'm not even going to entertain this idea.

Rollover into my new employer's plan

Well, my new employer doesn't have the best plan. I mean, there's the standard 6 or 8 fixed income options, various combinations of mutual and index funds, a few bond fund options. Some with higher management fees, which, surprisingly the guys from the company that setup the plan for us kind of steered people away from. Why offer it if you don't even recommend it... So okay, the new employer's plan isn't so hot, but no matter what, all my new money goes there. So next option...

Leave it with my old employer's plan

The plan with my old employer isn't bad, it's probably the best one I've had in my working career but I think that's more because my other plans were terrible. But overall, it's not fantastic either so I'm not really sure if I want to keep it sitting there.

Traditional IRA Versus Rollover IRA

So I know that I can rollover my old 401(k) into an IRA or a rollover IRA, but what is the difference between the two? Honestly, not that much. They are both tax deferred accounts, so you pay taxes on the money that comes out of the account. They both have the same penalty for withdrawing money before the age of 59.5, and the rollover IRA can be converted into a Traditional IRA at any time. In fact, the IRS treats all rollover IRA accounts the same as traditional IRA accounts. There is one small, or maybe it's a big difference between them. The purpose of the rollover IRA is to separate those funds from the funds that may not be eligible to transfer back into an employer sponsored retirement plan such as a 401(k) or 403(b). If I mixed my old 401(k) funds with my traditional IRA funds then I may potentially not be able to roll those funds into a future employer sponsored plan.

So I think I know my plan now, I'll be using the Rollover IRA option. It keeps the money eligible to rollover in the future if I ever change jobs again, and for now I get the flexibility of making my own investment plan with the options available with the broker of my choice. Now I just have to get the rollover started.

Are there any other points that you should consider before a rollover? Are there any other options I failed to mention? I know that you can do a rollover to a Roth IRA but I already have a lot of funds there and I don't want to get hit with a large tax bill for converting the funds.

3 comments:

  1. Thanks for sharing this, Zee! I don't currently have a 401(k), so I won't run into this at my next job, but I'll keep it in mind for the future!

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    1. This was always one of those simple questions that I just never really took the time to look into. Thanks for stopping by!

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