Understanding IRA Rollovers

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When leaving a job, qualified retirement plan participants generally have four options for managing their 401(k) assets:

  • Cash out their account
  • Leave the money with their previous employer’s plan
  • Roll it over to the new employer’s qualified plan
  • Roll it over into an individual retirement account (IRA)


Cashing Out

Cashing out on a retirement benefit can be a tempting opportunity; however, investors may want to consider this move carefully. Why? For one simple reason: it can be costly, both now and in the future.

The U.S. government discourages pre-mature distributions by imposing an immediate income tax obligation and a possible early withdrawal penalty for plan participants younger than 59 ½. Consider the following example of cashing out prior to 59 ½:

Distribution amount $50,000
Income taxes (assuming tax rate of 25%) $12,500
10% penalty $5,000
After-tax amount $32,500
   

Example has been simplified for illustrative purposes. At the time a distribution is made, 20% of the total amount will be withheld for income tax purposes. An investor’s actual income tax obligation will be calculated at tax filing and may be worth more or less depending on his or her income tax situation. State and local taxes may also apply.

Perhaps most important, participants who cash out could be compromising their ability to live comfortably down the road.

Staying Put

Leaving the money in a former employer’s plan is another option to consider. The benefits include convenience — no action is necessary — and continued tax-deferred growth potential. Depending on plan document provisions, participants may have access to loans and hardship withdrawals. But there are drawbacks. For instance, participants will not be able to make additional contributions to the account, and investment options will be limited to those offered in the plan, which can change unexpectedly over time. Finally, there may be additional risks and limitations due to future changes in the plan.

Rolling Over

Participants have two choices when considering a rollover. They can transfer the proceeds into a new employer’s plan or into a rollover IRA. Both moves may allow for future contributions and tax-deferred growth potential, but a rollover IRA offers additional benefits:

  • Consolidation: Participants can combine assets from other qualified plan accounts, such as 401(k)s and other IRAs, into one account.

  • Control: Participants have access to a variety of investment options and maintain full control over how the money is invested.

  • Flexibility: Participants can rollover their assets another employer-sponsored plan at a future date.

  • Access, in certain circumstances: IRAs permit investors to take penalty-free withdrawals to pay for higher education costs, a first-time home purchase, or qualified medical expenses. Although many employer-sponsored plans allow loans and hardship withdrawals, they generally do not permit distributions for those participants younger than 59 ½ (some exceptions apply).

Participants can choose one of two types of rollovers – a direct rollover or an indirect rollover. In general, a direct rollover may be easier, as it involves less action on the part of the investor. In an indirect rollover, a check is made out to the employee, who then must reinvest the assets in an IRA within 60 days. But there’s a catch: Twenty percent of the original account is withheld to apply to income taxes. When rolling over assets, the employee must make up this 20% out of his or her own pocket – or else the difference will be treated as a distribution and therefore subject to taxes and potential penalties.

Direct Rollover Indirect Rollover
Assets are transferred directly to the new IRA Employee receives check made out to him or her, then opens an the IRA to invest the assets
   
No tax withholding 20% mandatory withholding, must be made up out of pocket to avoid income tax consequences*
   
No IRS time requirement 60-day limit to complete rollover
   
No temptation to spend the money Employee receives money — may face temptation to spend it!

*Note: If the indirect rollover of the full amount is successfully completed within the 60-day limit, the 20% withholding will be refunded in the form of a tax credit at tax time.

Review the Choices

Here is a quick summary of the options available to John Hancock 401(k) plan participants who are leaving their jobs.

IRA Rollover Stay Put Plan-to-Plan Rollover Cash Out
Continued tax-deferred growth potential no
Broad range of investment options, including Lifestyle and Lifecycle Funds maybe (depends on IRA)* maybe (depends on plan options) maybe (depends on plan options) no (unless money is reinvested)
Penalty-free withdrawals for education and first-time home purchase no no N/A
Loans no maybe (depends on plan features) maybe (depends on plan features) N/A
Protection from creditors/personal bankruptcy action no
Consolidation of other retirement accounts maybe (depends on plan features) maybe depends on plan features) no (unless money is reinvested in IRA)
“Stretch” distributions no no no (unless money is reinvested in IRA)
Future contributions no maybe (depends on plan type) no
(unless money is reinvested)
Defer withdrawals beyond age 70 1/2 no (unless account is converted to a Roth IRA) no

if still employed and if the plan allows
N/A
Access to money without securing “permission” of plan sponsor √** no no N/A
Online monitoring of investment performance maybe† maybe maybe N/A


*John Hancock IRAs offer Lifestyle and Lifecycle fund options
**Income taxes and an early withdrawal penalty may apply.
†John Hancock IRAs offer online account access.

Life changes are often overwhelming. Managing retirement assets doesn’t have to be. Setting up a rollover IRA with John Hancock can be fast and easy. Participants with less than $10,000 can simply click the Rollover Now tab at the top of this page. Those with more than $10,000 have the option to call 1-888-695-4472 for assistance.

A fund’s investment objectives, risk, charges and expenses should be considered carefully before investing. The prospectus includes this and other important information about the fund. To obtain a prospectus, call your financial professional, John Hancock Funds at 1-800-255-5291 or visit our web site at www.jhfunds.com. Please read the prospectus carefully before investing or sending money.

Beneficiary distribution options may be more limited than the plan participant. See the article “Beneficiary Basics for Traditional IRA Owners.”

This material does not constitute tax, legal or accounting advice and neither John Hancock nor any of its agents, employees or registered representatives are in the business of offering such advice. It was not intended or written for use and cannot be used by any taxpayer for the purpose of avoiding any IRS penalty. It was written to support the marketing of the transactions or topics it addresses. Anyone interested in these transactions or topics should seek advice based on his or her particular circumstances from independent professional advisors.