Withdrawals Before Age 59 1/2
In the event that you are considering early retirement, you can withdraw cash from your IRA before age 59½ without the 10% penalty with the "substantially equal periodic payments rule". You must withdraw a certain amount each year utilizing an IRS-approved calculation method. These kinds of payments need to continue until the later of:
a) reaching age 59 1/2
b) 5 years
Note that not all of your IRA funds must be restricted to this schedule as you can split an IRA into several IRAs and just start payments from one.
On the other hand 401k plan participants face a 10% additional tax if they withdraw funds before they are 59½. They also may not even have this option if still working as some 401k plans do not allow distributions of any kind while employed (it is common that 401k plans at larger companies permit hardship withdrawals and loans). The ultimate flexibility argues to conduct a 401k IRA rollover.
Differences for beneficiaries
Not until recently, did both spouse and non-spouse beneficiaries of the 401k IRA rollover have similar options, because the 401(k) beneficiary can shift money to an Individual retirement account. Not too long ago, a non-spouse beneficiary did not have this 401k IRA rollover opportunity.
Exceptions to withdrawal penalties prior to age 59 1/2
An individual retirement arrangement allows penalty-free withdrawals with regard to higher-education expenses and first-time home- purchases, which 401k IRA rollover plans and other employer retirement plans don't always offer. You can see a complete list of exceptions to IRA penalties for early withdrawals.
Other differences between 401k accounts and IRAs
IRA owners can have multiple IRAs with different investment goals and have the ability to withdrawal from any of the accounts. Each might have its own beneficiary. However 401k plans may offer a narrow range of investment options and you can only have one account.
It is far easier to determine investment expense charges with an IRA account. Unfortunately, with a 401k, you may not even have access to all of the plan documentations and 401k plan expenses are often much higher than they should be. You have no control.
The above points argue in favor of a 401k IRA rollover.
Advantages of 401k account vs IRA
Should you hold company shares that have appreciated significantly, having them in a 401k account brings special tax advantages. The appreciation on these shares are taxed in a beneficial manner known as the "net unrealized appreciation rules." These beneficial rules allow you to pull out company shares form the plan and pay tax on the gains at capital gains rates, rather than ordinary income rates. if one includes company shares in a 401k IRA rollover, gains on those shares when pulled out will be taxed at ordinary income rates (currently up to 35% federal).
Another advantage offered by 401k plans is that participants can extract money directly from the program without penalty when they leave the company upon reaching age 55.
Last, money in 401k accounts is provided some additional creditor protection. This difference is not important for most people but could be for those in particularly high risk professions (e.g. surgeons, builders, etc).
There you have it - a comparison of the IRA vs 401k and the pros and cons of each. Know you can hopefully decide if a 401k IRA rollover is advantageous.
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions