401(K) rollovers are considered an IRA account, technically. They are both investment accounts set up for retirement. However an IRA account can be set up outside your employment, and could be invested in many more types of investment vehicles than a 401(K). Contributions to both a 401(K) and IRA are made before tax, and you pay taxes instead on the money you withdraw when you are retired. You can do a 401k withdrawal and also an IRA withdrawal both before and after retirement age, but if you withdraw before you reach the statutory age limit, there can be penalties and taxes due and owing. They also both have contribution limits, although in a 401(K) you can contribute more than to a traditional IRA account. Confused yet?

When you leave your employer, you have the option to leave the 401(K) behind with the employer’s fund manager, or you can instead do what’s known as roll over your 401(K) to a new brokerage. Your rollover account is often referred to by brokers as “rollover IRA”, because once you roll over into a new account, the new account is not technically a 401(K) account any longer. This instead is a traditional IRA to which you have moved your 401K() fund balances.

A 401k rollover to IRA can benefit you, because the rules get relaxed on the new account. You are not prevented from withdrawing money, as you might have been at your old job. You will still be responsible for paying the taxes and penalties, which can be substantial at nearly 40% of the withdrawal amount; for that reason a 401k withdrawal is never recommended except for emergencies, or if you qualify for an exception such as paying for college (you will still owe taxes). But when you rollover your account, you can now invest as you see fit, and are not limited to the investments your employer has chosen for you. You can also invest your 401k in cash vehicles such as U.S. Treasury notes or T-bills, or money market funds and CDs. The choice is now yours, not your employer’s.

One other reason to roll over is that you can convert into a Roth IRA account when you roll over your 401k. Money you invest in a Roth IRA is invested with after tax dollars, but when you retire, you pay no taxes on the money you take out. This can be a significant savings – you could pay less by paying taxes today instead of in the future when the value of your account has grown. When you covert from a tax-deferred account into a Roth however, you will owe taxes on the money you previously invested with a tax-deferral, so check with your fund manager for conversion details. Right now, there are regulations which allow you to pay the taxes owed over time, so it’s not such a big hit all at once.

Taking your 401k rollover to an IRA makes sense on a number of levels. By moving your retirement funds today, you can gain control over your financial future and improve your returns.

Technorati Tags: Financial Ideas, Investing strategy, Retirement

Related posts:

1. What’s Wrong With Getting A Big Tax Refund?
2. What Kind Of Money Should I Put Away Before 2010?
3. If I Do The Roth Conversion, Can I Finance The Tax Payment?