If you have the luxury of rolling over a 401(k) to an IRA, in most cases you’ll probably be better off, and we want to summarize some of the reasons why.
For starters, with 90% of the American public taking the higher standard deduction instead of itemizing deductions, their charitable contributions are no longer deductible. However, if you are 72, you can take all or part of your RMD out tax free if you give it to your favorite charity through a QCD, even while taking the standard deduction. You cannot do this in a 401(k).
For a married couple, age 72, giving $6,000 to their church through a QCD, this would allow them the $28,700 standard deduction for tax year 2022, plus another $6,000 for a total deduction of $34,700.
If you’re under 59 ½, there’s a 10% premature withdrawal penalty for taking money out of your IRA. But if you need the money for higher education, you can take it out without paying the penalty. You can’t do that with your 401(k).
If you have multiple 401(k)s and you’re over 72, you have to take an RMD from each one, creating a lot of unnecessary paperwork. If you have several IRAs, you can take the entire RMD for all of them out of just one, or even better you could consolidate all the IRAs into one IRA to reduce paperwork, and then take this distribution.
IRAs avoid the 20% tax withholding while 401(k) plans do not. In a 401(k), if the plan sends the money directly to you, it’s required to withhold 20% of the amount. If you want to roll the entire amount of the original distribution over to an IRA within the 60-day deadline, you’ll need to use other sources to make up the 20% the plan withheld.
In an IRA, if the plan sends the money directly to you, there’s no 20% withholding rule, so you get the full original amount which can then be rolled to another IRA within the 60-day time limit.
It’s also easier to establish an inherited IRA for your beneficiaries, which can save them a significant amount in taxes. 401(k) plans generally require additional steps to establish an inherited IRA, which can create extra complications for the heirs to get an inherited IRA setup.
Lastly IRAs offer a much greater option of investment choices. You have the universe of qualified investments available vs. just the limited options offered in most 401(k)s.
This article is for informational purposes only. This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice as individual situations will vary. For specific advice about your situation, please consult with a lawyer, tax or financial professional. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.