Suppose you are a retired person living in Chicago or considering retirement soon. In that case, you likely have a substantial amount of money in one or more 401(k) accounts accumulated over the years. It is also possible that you have changed jobs a few times and thus have some 401(k) accounts with former employers that are inactive. But these accounts are not going to be neglected forever; what can you do with them instead?
This is the perfect time for a Chicago 401(k) Plan, which involves transferring retirement funds from your previous employer’s plan to a new account, such as an IRA or a 401(k) with a different employer. If everything goes as planned, it will keep your money in tax-deferred status, allowing you to have more control over the investments and, in most cases, lower your fees.
Here is an extensive guide that walks you through 401(k) rollovers, including the benefits they offer for your retirement plan.
What is a 401(k) Rollover?
A 401(k) rollover is simply the moving of funds from your former employer’s 401(k) plan to a new retirement account. Generally, you can roll it over to an IRA (Individual Retirement Account) or to the 401(k) plan provided by your new employer. You are not withdrawing the money to use it, but rather, you are moving it to a place where you will have more control or options.
Especially for retirees considering financial planning in Chicago, rollovers make even more sense. With Illinois generally not taxing retirement income, such as IRA or 401(k) withdrawals, you can focus mainly on managing your federal taxes and growing your savings in a more flexible account. Regardless, managing one or two consolidated accounts is way simpler than managing several old ones.
Therefore, a 401(k) Rollover allows you to keep your money tax-free until you withdraw it after retirement. Additionally, you are not required to pay income tax at the time of transfer.
Two Main Types of Rollovers
There are two main types of rollovers:
Direct Rollover
This is the safest and most common way. In this case, the money is transferred directly from your old 401(k) plan to your new 401(k) or IRA account. You don’t withdraw the money mid-transaction; thus, it stays tax-free and is at no risk of penalty.
Process: The funds are transferred directly from your old 401(k) account to the new one or an IRA.
Taxes: No taxes are involved. Additionally, there’s no risk of missing a deadline, and thus, no penalties either.
Indirect Rollover
This, on the other hand, occurs when a retiree receives their funds privately before having to deposit them into another account. Once you receive the funds from your old employer, you get upto 60 days to deposit that money into your new retirement account. If you miss the deadline or replace the 20% held in taxes, the IRS will treat it as a withdrawal.
Process: The initial checks are made out to you. You then have upto 60 days to deposit the full amount to a new one.
Taxes: Your administrator will withhold upto 20% of the amount for federal income taxes. You can recover this amount while filing your annual tax returns. Additionally, if you fail to submit within the 60-day window, your distribution will be considered taxable. If you are under 59 years, you may also face a 10% penalty.
Four Choices for your Workplace Savings or 401(k)
Keep it Where It Is(your previous workplace plans)
If your former employment allows, keep your funds where they are. This allows your savings to grow tax-deferred, although you will no longer be able to contribute.
Cash it Out and Pay Taxes.
If you withdraw any cash, it will be subject to federal and state taxes. If you are under 59 years of age, a withdrawal fee of 10% may also apply as a penalty charge.
Roll it into an IRA
By rolling it into an IRA, you can combine your previous workplace savings account, such as a 401(k) or 403 (b), and consolidate it into one account with your current employer. This allows your savings to grow tax-free.
Roll it to Your Current Workplace.
If your new employment allows, consider consolidating your previous savings and depositing them into a single account with your current employer. This will also keep your funds tax-deferred.
The Benefits: How Rollovers Can Help Retirees in Chicago?
Rolling over your 401(k) after retirement can bring numerous advantages, especially for retirees living in and around Chicago. It is one of those retirement plans for employees that is not merely about money. It’s about taking control of your lifelong savings. Here are some of the top benefits Chicago retirees can enjoy from a smart 401(k) rollover:
Easy Management through Consolidation
Over the course of a long career, many Chicago employees end up with multiple 401(k) accounts from different employers. Rolling them into a single IRA or retirement plan helps you keep everything in one place.
More Investment Choices
Many 401(k)s charge plan management fees or restrict low-cost investment choices. By rolling it over into an IRA, you can access a wider range of investment options, including institutional class funds with a low expense ratio. This results in lower overall fees compared to some employer-sponsored plans. Regardless, before finalising, it is crucial to compare the fee structures of all your plans, the old, new and IRA options.
Continued Tax-Deferred Growth
When done properly, a rollover is not taxable at the time of transfer. Your funds continue to grow tax-free, just as they did in a 401(k). This means your funds can continue to increase until your first withdrawal.
Illinois’ Tax-Friendly Treatment of Retirement Income
Here is where financial planning in Chicago gets a special advantage: Illinois does not tax most retirement income. This includes 401(k), IRA and pension withdrawals. That means you can continue to work with your rolled-over funds without worrying about state income tax. This is a huge plus compared to retirees in many other states.
Easier Required Minimum Distribution (RMD) Planning
Once you have reached the RMD age, having your savings combined in an IRA makes the process much simpler. You only need to calculate RMDs from one account instead of multiple 401(k) accounts. This makes tax planning and withdrawal timing much easier.
Although these are some of the top benefits, others include a smoother transition in case you return to work later. Additionally, if you later qualify to contribute to an IRA, your retirement savings remain flexible and aligned with your financial goals.
Step-by-Step on How to Do A Direct Rollover
Decide where to move your funds:
Deciding whether to contribute to your current employer’s 401(k) plan or a traditional IRA is a crucial decision. Before making your final choice, compare fees, investment choices and special protections you may lose. Especially, as a Chicago resident, you should remember that state tax on retirement withdrawals is generally not an issue; however, federal taxes still apply.
Request the rollover:
Fill out the old plan’s distribution/rollover form and specify “direct rollover” or “trustee to trustee transfer.” Contact the administrator of your current plan and the new plan, or your financial advisor for retirement, to learn about the specific details on how to roll over your 401(k). Submit all the vital forms requesting the rollover.
Help or Track the Transfer Process
After your old plan processes the rollover, your money will be sent to your new 401(k) or IRA. If it is a direct rollover, the check will typically be made out to your new plan or institution, rather than to you. However, if the check is made out to you, it becomes an indirect rollover. In that case, you need to deposit the full amount into your IRA within 60 days to avoid taxes and possible early withdrawal penalties.
Investing Your Funds:
After IRA or your new plan receives the funds, you will need to select your allocation of funds in the account. However, if you are unsure about how to choose your investments, it’s best to work with a retirement planning advisor.
Read More : Can You Roll Over an Annuity to an IRA
Common Pitfalls to Avoid
Missing your 60-Day Deadline:
If you receive the money yourself and fail to redeposit it into another qualified account within 60 days, it will become a taxable withdrawal. That means you could owe income taxes on the entire amount, along with a probable 10% penalty for early withdrawal, if you have not reached the retirement age yet. Therefore, it is best to avoid indirect rollovers unless necessary.
Overlooking Plan-Specific Benefits and Tax Implications
A few older 401(k) plans come with benefits such as institutional fund pricing, company stock with Net Unrealised Appreciation (NUA) advantages, or loan provisions. Rolling over too quickly may mean losing these benefits. Additionally, it is equally crucial to understand the tax implications that come with these plans. In case you need an advisor, watch out for the best financial advisor companies in Chicago for expert help.
Mixing Pre-Tax and Post-Tax Funds Incorrectly
In case your 401(k) includes Roth contributions (after-tax funds) that need to go into a Roth IRA, while your traditional (pre-tax) funds go into a Traditional IRA. Mixing these up may trigger additional charges or penalties.
Not Reinvesting After the Rollover
Few people complete the rollover process successfully, but leave their money sitting in cash at their new institution. This means your funds are not growing. If you move your money into a new 401(k) plan, your employer’s plan may put you into a default investment option. However, if you roll your fund into an IRA, the funds usually remain in cash until you choose to invest them.
Rolling Over Required Minimum Distributions (RMDs)
Once you hit the RMD age(73 under federal law), you must take out your annual RMD before initiating a rollover. If you accidentally include your RMD in the rollover, the IRS treats that amount as an excess contribution, which could result in tax penalties and additional paperwork.
To Sum it Up
Knowing the right way to roll over your 401(k) will simplify your retirement planning. A 401(k) is not just mere paperwork; it is a strategic move that shapes your retirement comfortably. By transferring your savings into the right account, you gain more flexibility, control and long-term growth potential.
For retirees in Chicago, the advantages are even greater. With Illinois’ tax-friendly treatment of retirement income, you get to keep more of what you have earned while enjoying simplified account management and better investment choices.
However, it is vital to consider investment choices, fees, and tax implications before making a move. For optimum results and a correct procedure, contact the best financial advisors in Chicago.
