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401k Rollover — Is It Right For Me?

What is a 401k and How Does It Work?

Let’s start with the basics. A 401k plan is an employer-sponsored retirement plan that allows you to save money for retirement while deferring income taxes on the savings until the time of withdrawal. As an employee, you can opt to have a portion of your income paid directly into the 401k account. Employer-sponsored plans can either be participant-directed (where you choose from a variety of investment options) or trustee-directed (where assets are investment by a board of trustees). Investments typically consist of mutual funds focusing on stocks (including, perhaps, your company’s stock), bonds, and money market funds or stable value investments.

What is a 401k Rollover and When Can It Occur?

A 401k rollover refers to the process of taking the money out of your 401k and moving it into a different retirement plan. This typically takes place when you leave your company or retire, and is also referred to as “separation of service.” There are several rollover option s available to you once you separate from service:

Take the Cash

With a lump-sum payout, you can count on losing a huge chunk of your savings to taxes. If you are over 59 ½ and you choose to cash out the 401k, it will be taxed as current income. Your company will deduct 20% of your savings and hand it over to the IRS as a pre-payment on your income taxes. If you choose to reinvest you will have a lot less money to work. If you are under 59 ½, you may be forced to pay a 10% “early withdrawal” penalty, in addition to the 20% paid to the IRS. If you take the cash all at once, you will be required to report the entire amount on your income taxes for that year. This amount, in addition to your other annual earnings, can bump you into a higher tax bracket. In either case, cashing out your 401k is generally one of the worst decisions you can make when it comes to optimizing your retirement dollars.

Leave the Money in the 401k

When some people leave their job or retire, they leave their money in their 401k plan. Your current company is obligated to let you keep your money in its plan, even if you leave, as long as it exceeds $3,500. If you go to a new employer, you can usually transfer your old 401k money into the new employer’s 401k account. You will now have the advantage of one account statement instead of two, and your investment options will be different in the new plan. But keeping your money in the 401k is, next to cashing out, the second worst thing you can do with you retirement money. The money is still restricted to a defined set of investment options dictated by your company’s plan. All 401k plans have limited investment options, no safeguards against losing your principle, and no income protection for your retirement years

Roll It Into an IRA

An option that is usually better than leaving your money in the 401k is to roll it into an IRA (Individual Retirement Account). There are a wide variety of IRA investment options out there, and you can choose one that you like, rather than be tied to the investment options pre-selected in your 401k. However, IRAs do not provide safeguard of principal or benefits such as income protection as you get older.

Roll it Into an Annuity

When you leave your job for a new one, or retire, you have a one-time opportunity to take the money from your 401k account and transfer it into a better investment vehicle, like investments with more flexible investment options, safeguards against losing your principle, and income protection for your retirement years. We firmly believe that investors retiring or changing jobs should at a minimum look into seizing the opportunity to transfer their investment dollars out of the generally restrictive 401k plans, and into more flexible plans such as annuities. Rolling your 401k into an annuity gives you a continued tax shelter, while permitting you a huge range of investment options, guarantee of principle options, and living and death benefits that can protect you and/or your family whether the stock and bond markets go up or down and regardless of whether you live or die.
If you choose to roll you 401k into an IRA annuity there are two primary types, Immediate and Deferred. With an Immediate Single-Life Annuity, you will receive one check per month for the rest of your life, no matter how long you live. The amount of this monthly check is determined by the size of your account, the interest rates at that time, and your life expectancy. With a joint-and-survivor annuity, the amount of each check will be 10% to 15% smaller because they will be sent every month for as long as you or your spouse is alive. You can also opt for a life with 5, 10, or 20-year certain contract, which will guarantee that monthly checks are sent to your heirs after you and your spouse are deceased. With an immediate annuity you are giving up control of your principal and therefore it is important to understand that you are giving up all of your money in exchange for a series of payments. With a Deferred Annuity you maintain control of your principal, and can receive guaranteed payments while benefiting from potential upside in the stock market. This is accomplished through the purchase of additional riders that will guarantee at a minimum a 5-7% worst-case return on your money, but if the market does better you are guaranteed the higher return and can lock in your new higher principal value to increase your income.
A word of caution: always check with your company prior to making a rollover to see if they offer a payout that is higher than you could get from insurance companies. Most financial advisors won’t suggest this possibility, because if your company’s payment is higher the advisor won’t get a commission. Once you roll over your 401k you can’t roll it back, so look before you leap! If your employer does not offer to annuitize your 401k, you can take a lump sum payout from your 401k and use the funds to purchase an annuity contract — just be sure and do so within 60 days of the 401k distribution to avoid any taxes, and be sure the check is made out to the new custodian FBO (for benefit of) you, so that the IRS will not deduct 20%.

Advantages of the 401k Rollover Annuity:

  1. Guaranteed Principal: Principal is guaranteed with a 401k rollover annuity, while principal is not guaranteed with mutual funds, stocks, or bonds associated with your 401k or IRA investment.
  2. Flexibility: When you roll your 401k plan into an IRA within a variable annuity, you have the power to change your investments depending on the investment climate or your personal goals. For example, you can select a fixed interest rate account, or have the option of splitting up your account between market indices, actively managed funds, asset allocation models and fixed interest account(s).
  3. Income Protection: With the best variable annuities with living benefit riders or immediate annuities with life contingencies, you cannot outlive your money. As long as you are alive, the insurance company is obligated to send you a check every month.
  4. Death Benefit Protection: With the top deferred variable annuities, for an additional fee (usually 0.25% to 0.75% per year), most insurance companies offer what are referred to as “Enhanced Death Benefits.” These benefits vary from 3% to 7% on either a simple interest or compounded roll-up that grow to age 80, 85 or even 90, or the highest monthly, quarterly or annual account value. A couple of companies will even lock in the highest anniversary value and then pay you 5% or 6% off of the new, higher value.

Additional Resources

Your Guide to 401k & IRA
Rolling an IRA Into an Annuity

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