So you start a new job, leaving behind an old employer sponsored plan. What are your options? What can you do with it?
If you participated in a former employer’s retirement plan, you are not stuck, in fact you can roll it over in an IRA account with Wahed Invest.
A self-directed IRA allows you to take advantage of a halal diversified portfolio at Wahed Invest. If you end up taking a distribution in cash – it will cost you a lot in taxes and future retirement savings. IRS tax laws treat a “direct” and an “indirect” rollover differently, and you could end up with an unexpected tax bill if you don’t know the difference. Make sure to seek proper tax advice from a tax specialist.
Let’s take a look at two hypothetical examples that will walk you through the two methods for rolling over assets from former employer’s retirement plan to an IRA.
The following hypothetical example walks through the two methods for rolling over assets from a former employer’s retirement plan to an IRA.
Rollover Options for Salman
Salman, age 38, left his employer after 15 years to work for a new company. Salman has been consistently deferring some of his salary into a 401(k) plan since he started working for his former employer and has accumulated $80,000 in his 401(k) account. Salman knows that he should keep investing and growing his nest egg for retirement. So, Salman decides to roll over his pre-tax 401(k) savings to a self-directed Traditional IRA. He consults with a financial advisor to explore options for moving his money to an IRA.
Option 1: Indirect rollover
Salman can request that his former employer’s 401(k) plan pay out his $80,000 account balance by mailing a check to him or sending the dollars to Salman’s checking account. Salman then has 60 days from the day he receives the money to complete the rollover to the IRA. This is due to the tax laws that require the plan to withhold 20% of the gross distribution amount and send it to the IRS as prepayment of the income taxes due on the distribution. This means that Salman will receive a check for only 80% ($64,000) of the total distribution of his 401(k) account. The other 20% ($16,000) is sent to the IRS by the 401(k) plan trustee.
Any amount Salman deposits into an IRA within 60 days will not be taxable to him (until he withdraws it from the IRA). To avoid being taxed on the $16,000 withheld and sent to the IRS, Salman must come up with $16,000 from another source to deposit into the IRA so he can complete a rollover of the full amount distributed from the 401(k) plan ($80,000). If he does this, Salman may receive a refund of some or all of the 20% withholding amount when he files his federal income taxes for the year.
If Salman does not have an extra $16,000 to make up for the amount that was withheld, Salman will have to include an extra $16,000 in his taxable income for the year. And, because Salman is younger than age 59½, unless he meets an exception to the early distribution tax, he will also owe an additional 10% tax on the $16,000 ($1,600).
Option 2: Direct rollover
Salman can request that his former employer to directly rollover his 401(k) account balance to a self-directed IRA. When the assets are moved directly from the plan trust to the self-directed IRA custodian in a direct rollover,
- Salman will not have access to the money,
- There is no income tax withholding, and
- 100% of the gross distribution will be rolled over.
Salman will not have any tax consequences and his retirement savings will continue to grow tax-deferred in his IRA until he chooses to withdraw them (ideally, not until he retires).
Now let’s understand the purpose of the 60 Day rule:
Congress created these complex tax rules to discourage individuals from using the indirect 60-day rollover option because there is a temptation for individuals to spend their retirement savings before retirement. Many people are not aware of how the withholding rules impact their tax liability and rollover options. If you have money in a former employer’s plan, be sure to seek advice from your tax professional before asking for a distribution.
Schedule a call to discuss your Wahed IRA or visit the IRS website for more information on IRA eligibility.
If you have questions about IRA account offered by Wahed Invest, you may also contact me at 855-976-4747 or [email protected] or please visit wahedinvest.com.