When It May Not Make Sense to Roll Over Your 401(k)

Contrary to what most experts advise, there are times when it may not make sense to roll over your 401(k).

We even advise most investors against leaving behind an old 401(k). 

However, there is an IRS rule that – if you qualify – may help you have more money and avoid penalties that could eat into your retirement income. 

It’s called the 55 and Separated from Service Rule. 

If you aren’t aware of this provision and you roll over your 401(k) should you retire early, change jobs, or be terminated, it may be a costly mistake.

Keep reading for more on this IRS rule and why it may not make sense to roll over your 401(k).

What Is the 55 and Separated from Service Rule?

The Separation from Service exemption is an IRS provision that allows you to take penalty-free distributions on 401(k)s if you leave your job during or after the calendar year you turn 55. 

It’s also called the Rule of 55, or 55 Rule. 

It gives 401(k) investors, who are looking to retire earlier than normal or those who need the cash flow, a way to take distributions from their retirement plans sooner than is typically allowed.

Normally, any withdrawals prior to age 59½ would have a 10% early penalty from the IRS. But, if you take advantage of this rule, you can avoid paying the early withdrawal penalty. 

You will, however, still owe ordinary income tax on the amount you withdraw

When It Doesn’t Make Sense to Roll Over Your 401(k)

Typically, it’s advisable not to leave behind an old 401(k) with a past employer. 

However, if you’re nearing age 55 or are already 55, it may be in your best interest to leave the 401(k) where it is and NOT roll it over. 

Here’s why: If you are over the age of 55, but under 59½, and you roll over your old 401(k) to an IRA, the 55 and Separated from Service Rule no longer applies to you. 

That means, if you need to take a withdrawal from your new IRA – the old 401(k) – you will have to pay the 10% penalty, plus taxes.

If you leave all or some of the money in your old 401(k), you can withdraw from it without penalty thanks to the 55 Rule.

A lot can happen in the years between 55 and 59½. If you think you may need to access part of your 401(k) funds in those years, it may be in your best interest not to roll over all the money into an IRA.

Get Help Before You Make Your Move

Every investor’s situation is different, and we recommend you speak with an advisor who can help you navigate the rollover process and help you make the best decision possible for your financial future.

Have questions about rolling over your 401(k)? Book a complimentary 15-minute 401(k) Strategy Session with one of our advisors.

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