New 401(k) Rollover Rules

March 10, 2009
Special Feature

Up until a few years ago, when the owner of a 401(k) account died, only his/her spouse was allowed to transfer the assets into an IRA.

Up until a few years ago, when the owner of a 401(k) account died, only his/her spouse was allowed to transfer the assets into an IRA. Any other beneficiary, including the owner’s children, grandchildren, siblings, or significant others, was forced to cash out the 401(k), often with disastrous tax consequences. Congress changed those rules three years ago, but a decision by the IRS the following year opened a loophole that let employers choose whether to allow the transfers. In December of last year Congress enacted a law that closed that loophole, giving companies until January 1 of next year to comply.

The advantage is that all heirs can now transfer assets to an IRA and take out distributions based on their life expectancy. The money taken out would be taxable, but the tax bite would be spread over a longer time period instead of paying taxes on the lump sum in the 401(k). The rule removes one of the disadvantages of leaving your retirement funds in your 401(k) when you retire or leave your job.

There are still reasons why transferring 401(k) funds to an IRA when you retire or switch employers may be a good idea. The most significant one is that an IRA would offer you a much wider range of options, especially lower-cost investment choices. Avoiding the high expenses that many 401(k) plans charge can make a big upside difference in your long-term returns.