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Retirement education

A Smart Way to Simplify Your Financial Life:
Consolidate 401(k) plans with a rollover IRA 

If you're like a lot of people, you probably have assets scattered among a number of different investment plans. One common reason for this situation is that many people move on to new jobs but leave their investment money in their former employer's retirement plan - usually a 401(k) plan. You may have wondered what to do with those assets but just haven't had the time to research your options. 

When leaving a job where you contributed to a plan such as a 401(k), 403(b), 457 or pension plan, here are four choices you can make:

  • Take a cash payout
  • Leave the money in the plan
  • Roll the assets into your new employer's plan
  • Roll the assets into an individual retirement account (IRA) 

It's always tempting to take part or all of your plan assets as a cash payout, but in doing so you may lose a good portion of your money to income taxes and possibly a tax penalty for early withdrawal, depending on your age. While you won't suffer any tax consequences by leaving the money in the existing plan or moving it to your new employer's plan, you may be limiting the full potential of those assets. Rolling your money into an IRA offers several features that may appeal to you. 

Five reasons a rollover IRA may be right for you

1. Deferred taxes. When you roll your assets into an IRA, there are no immediate tax consequences. Once your money is in the IRA, it will continue to grow tax-deferred until you decide to take distributions. 

Conversely, should you choose to take a payout from your employer's plan, those assets will be taxable and also may be subject to a 10% early withdrawal penalty if taken prior to age 59 1/2. 

Assuming that you invest the assets from your employer-sponsored plan into the exact same investments in a non-retirement account, those assets in a tax-deferred account, such as an IRA, will generally result in greater capital accumulation by the time you retire than funds in a non-retirement account because of the IRA's tax deferral and penalty-free rollover benefits.

Case Study
Consider the financial scenarios of two individuals. 

  Investor A Investor B
Age 45 45
Situation Recently laid off from job Recently laid off from job
401(k) plan account balance at time of layoff $100,000 $100,000
Action taken Immediately rolls entire balance over into an IRA account Cashes out half of balance ($50,000) and pays income taxes and 10% early withdrawal penalty but immediately rolls the other half ($50,000) over into an IRA account
Return earned 5% per year 5% per year
Result At age 65 has a balance of $265,330 At age 65 has a balance of $132,665

Source: www.irs.gov
 


The information in this hyothetical example above (5% return, compounded annually) is used for illustrative purposes only and is not intended to predict the actual performance of any particular investment.

CATCH-UP CONTRIBUTIONS - SEEING THE BENEFITS

  Save an additional $500/year Save an additional $2,000/year Save an additional $4,000/year
For five years $2,983 $11,932 $23,864
For seven years $4,500 $18,000 $35,999

Each hypothetical example assumes a 7% annual return, compounded monthly. This rate is used for illustrative purposes only; actual returns received by an investor may be significantly different. The calculated balances only reflect the additional catch-up contributions and earnings for each participant. This provision is scheduled to expire after 2010, unless the law is changed prior to that time.

The annual limits on both regular and catch-up contributions are scheduled to increase in the future. Regardless of your age, maximizing your contributions to retirement plans and IRAs is a tax-smart way to prepare for the future.

A plan of regular investing does not assure a profit or protect against loss in a declining market. You should consider your financial ability to continue your purchase throughout periods of fluctuating price levels. 

2. Convenience. It's difficult to get a handle on just what you have in your overall retirement account when you're receiving several statements from a number of different companies every quarter. By consolidating these assets into one account, you can get a better idea of what you own by reviewing one simple statement. This consolidation also can help you avoid two common investing pitfalls: 

  • Investment overlap - Occurs when you own different funds and aren't aware they hold the same or very similar investments.
  • Shifting asset allocation - Over time, changes in the market can cause shifts in your asset allocations. By moving your money into one account, you may find it easier to review and rebalance those assets so that your investment allocations continue to match your risk tolerance and goals. 

3. Control. With an IRA, you can invest at any time through one plan rather than having to go through a 401(k) provider. 

You also have more complete control over your assets at all times. In general, IRA rules allow you to take distributions, free of the 10% early withdrawal penalty, for:

  • Financial hardships
  • The purchase of a first-time home
  • Higher education bills 

4. Choice. Investing in an IRA allows you to choose the investment companies and the individual investments you prefer rather than being limited to those offered in your former employers' plans. This flexibility often provides a much broader range of investments - from stocks and bonds to mutual funds with varying objectives. 

5. Ease for beneficiary. If you think it's confusing to stay on top of your assets, imagine how difficult it would be for a beneficiary to track down the various plans and then have to handle several sets of paperwork. With one IRA, your beneficiary will be able to find all the necessary information in one place. 

Implementation made easy: A Nationwide Funds rollover IRA 

Nationwide Funds Group offers a wide range of mutual funds built on sound investment management processes. Whether you're retiring in 30 years or in five, we think you'll find that our extensive selection of investments, ranging from aggressive to conservative, likely has a suitable option for your time frame, needs and goals.  Before consolidating your accounts, please check with your financial professional concerning any fees or charges that may apply.