Advantages of Rolling 401k Into Rollover IRA vs. Traditional IRA

Question: Is there any advantage to rolling my 401k into a Rollover IRA instead of a Traditional IRA?

I already have an Traditional IRA and two 401(k)’s from previous employers. I would like to consolidate my accounts so I can track them more easily. I would like to get some feedback on your thoughts on whether I should roll the 401(k)’s from my prior employer into a Rollover IRA or if these should be transferred to an existing Traditional IRA.¬†Additionally, are there any consequences regarding later converting the IRAs to Roth IRAs a later time?

Answer:

A Rollover IRA is essentially a Traditional IRA. In other words, a Rollover IRA is a Traditional IRA by default. The same withdrawal and tax rules would apply. Since they are both qualified retirement accounts, there will be no tax penalty from transferring funds from a 401(k) to a Rollover IRA or Traditional IRA. That is because they are both pre-tax account, meaning that taxes are due when the money is withdrawn. If the funds are converted to a Roth IRA, there would be tax consequences since a Roth IRA is an after-tax account that allows you to withdraw the money tax free.

If you wish to rollover the money in your 401(k) into an IRA, inform your employer that you wish the funds to be transferred to an IRA and make the check payable to the brokerage company that you use. Therefore, the transfer would be a trustee-to-trustee transfer which avoids the 20% tax withholding.¬†If you take receipt of the money, the employer is required to withhold 20%. If the funds aren’t deposited into an IRA within 60 days (including the 20% withheld), whatever is not invested is treated as income and you will owe a 10% penalty on that amount. If you deposit the full amount of the 401(k) funds, you’ll receive the 20% withheld as a tax credit or refund. However, it will be best to avoid this headache by simply completing a trustee-to-trustee transfer.

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