One of the most valuable assets savers possess is their 401(k) plan. You’ve spent all your life saving your hard-earned money into your company provided 401(k) plan until hopefully, at some magical day, that day arrives when you are ready to retire or arrive at what I call halftime. That’s the period of time where you’re almost ready to retire and you’re thinking, boy, I wish I could go on and retire now. It’s a very crucial decision to make the final determination of when to rollover your 401(k). More importantly, who in the heck you are going to roll it over to anyway.
You know that you only have one shot to get this 401(k) rollover right. Regardless of whether you have $50,000 to invest that’s sitting in a 401(k) or maybe $5 million dollars, In this blog. I’m going to share with you the seven biggest misconceptions that savers make when it comes to understanding how best to rollover one’s 401(k) plan.
Now, let’s get something straight. A 401(k) plan is what we refer to in this business as a qualified plan. A qualified plan, as opposed to non-qualified savings plans or investing, is actually a plan that receives special treatment from the government in terms of how the plan is going to be taxed. I speak to people who sometimes get really confused with the government acronyms that are associated with all these different 401(k) accounts.
For instance, a 401(k) plan might also be referred to as a 403(b) plan. It could be referred to as a 457 plan, a thrift savings account, or simply an individual IRA. Also, there’s a qualified account known as a Roth IRA. These again are qualified accounts given special tax treatment by the federal government.
Don’t let all these different acronyms confuse you. Basically, there’s only two types of accounts. Ones that are pre-tax, meaning you do not pay any taxes on the front end but rather you pay taxes on the back-end. That’s when you go to take the money out. And then there’s accounts which are called after-tax, which would be, for instance, the Roth IRA whereby you pay the taxes now. When you take it out down the road there are no taxes due.
Well, in my 34 years of experience in the 401(k) trenches, one thing I’ve learned– and it’s very important to understand this, the government is giving you a tax break. Which means that if the government’s involved in it, it can be very confusing and complicated. If you do the wrong thing, if you don’t get this stuff right, it could be very, very punishing to unsuspecting savers who rush out and rollover their 401(k)s into other accounts, particularly with other financial advisors or financial institutions.
I want to give you a better understanding of how the rules of the game work. Because in some cases while you could possibly roll it over again, there’s not a lot of do-overs right away. If you botch this rollover and move your money into investments you don’t understand or that come with huge penalties or unnecessary risks, it could cost you big time. Let’s jump into the seven misconceptions.
- I can only rollover my 401(k) when I reach full retirement, for instance, age 65 or 66. This is a biggie, that there are many opportunities to roll your 401(k) over into safer territory and best of all, with a local fiduciary such as myself who can meet with you one on one and help strategize what to do with this 401(k).
- If I roll my 401(k) over aren’t I going to have to pay an immediate 20% tax penalty? And in some cases, yes. If you send that 401(k)-rollover check to you personally, your employer is required to withhold 20% in taxes. A proper rollover over to what we call another qualified account, if done properly should not have any current taxation.
- If the 401(k) is rolled over prior to 59 and 1/2, won’t I incur a 10% tax penalty? Again, that’s a misconception. What that’s referring to is if you take money out of a 401(k) or IRA prior to 59 and ½, and even with 401(k)s there’s some exceptions to this, you will have a 10% tax penalty. For instance, my mother-in-law, recently passed away unfortunately. I knew that lady for42 years. Very sad loss. My wife inherited her IRA. And my wife is under 59 and 1/2. So, if she just liquidates that thing, not only will she have to pay taxes but she’ll incur a 10% tax penalty.
- Former 401(k) plans at previous employers cannot be rolled over prior to a 59 and 1/2, which is not true. For instance, some of you have changed jobs. You’ve got this old 401(k) languishing over there somewhere at some old job that you had, and you forgot all about it. You thought to yourself, I guess I’ve got to leave it there. Or worse yet, I’ve got to roll that into the next 401(k) that I’ve currently got. And that is not correct.
- Never roll over an account that is already tax deferred. Many financial pundits who don’t understand retirement planning or income planning, these financial know-it-alls out there, assume because the 401(k) is tax deferred, why would you put an annuity, which is tax deferred inside a tax deferred plan? It doesn’t matter. The reason we put annuities in rollovers accounts is because it’s the only form of Mailbox Money® you can get. Why in the world wouldn’t you want mailbox money coming out of that 401(k)? We can show you how to do that.
- The fees will be less if I keep everything the same. Let’s say you’re with Shifting Sands of Texas and they’ve got your 401(k), then you retire. Then you approach them and they say, “We’ll roll that into an IRA for you. Don’t move that over to Walker or some of these other people. And will save you a whole lot more money in fees.” That, my friends, sometimes is not the case. So be very, very careful with the existing custodians, that’s the people currently handling your 401(k), telling you that they can do a better job and they’re much cheaper if you roll the 401(k) into one of their IRAs.
- If you don’t like the plan, person, or investment you just roll your money over to someone else. Now, I’m going to show you an example of how dangerous and restrictive a poor choice can be for rollovers. I’m going to use my favorite example here of a dinner seminar. Again, let me clarify something. Although we have a lot of fun with these dinners seminars there is nothing wrong with dinner seminars. In fact, I’m sure you can get some good information at them. If we talk about a dinner seminar from a prospective client standpoint, there is inappropriate activity going on following the dinner seminars. In cases where people are going to these dinners seminars they’re getting caught up in the fact that maybe somebody’s bought them dinner and they’re sharing some information, they get disturbed. That’s when the squeeze gets put on. Let me share this example of something that really happened where somebody got very impatient and wanted to react very quickly to a dinner seminar. They attended the dinner seminar. The nice lady pitching the products in Bowling Green, then she said something according to my prospective clients, something to this effect. “I am the only person in the state of Kentucky that is set up to handle taking applications for annuities, certified and annuity paperwork. So, folks, if you want to start right now, we can start the paperwork now.” Most people’s food hasn’t even digested yet, and apparently this lady’s claiming that you’ve got to act now. So, I said to myself, who in the world is this? I Googled this person. I couldn’t find a website on them. No credentials but here are unsuspecting savers getting ready to hand over their life savings to somebody who is pressuring them to act now as if there’s some hurry to all of this.
In conclusion, many of you have taken 20, 30, 40 plus years to save money for retirement. What I would say is, as my dad used to say, just slow down. Let’s sit down and talk about it. And let’s move at YOUR pace. More importantly, before you make any decisions on a 401(k) rollover, make sure you have a game plan. Most important, make sure the advisor with the game plan puts it in writing, and takes their time with you. All things considered, make sure whatever they’re recommending is right for you and only you.