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A Rollover Primer Part 2: Age 55 to 59 1/2

If you are between the ages of 55 and 59 1/2 and are changing jobs, rolling your retirement funds from your former employer to an IRA is not an automatic decision. Normally it’s a good strategy to roll retirement plan funds (such as from a 401k or a 403b) to an IRA any time you change jobs. Doing so avoids immediate taxation on those funds as well as a potential 10% early withdrawal penalty. But if you are age 55 to 59 1/2, you may be able to avoid that 10% early withdrawal penalty.

This exception to the penalty is often referred to as the “separation from service” rule. If you are past age 55, you could take money from your former employer’s retirement plan (and spend it, invest it, etc.) without being subject to the 10% penalty. Of course, that retirement money would be counted as taxable income, so all this option really grants you is the ability to avoid the penalty. Any or all of the retirement money you take out is taxable. If your account is worth a few hundred thousand dollars, that could generate a pretty big tax bill for any given year. In that case, rolling your old employer’s retirement money to an IRA would still make sense.

What if you do roll your ex-employer’s retirement plan money to an IRA? The age 55 penalty exception doesn’t apply to IRAs, so you’d face the 10% early withdrawal penalty if you wanted to tap into it. Or you would need to wait until you reach age 59 1/2, at which point you can take money from any type of retirement plan without worrying about the 10% penalty.

So one of the key questions for anyone age 55 to 59 1/2 to ask is whether you think you’ll need to tap your old retirement plan money before you reach age 59 1/2. If so, you may not want to roll that money to an IRA. It’s important to remember this retirement money needs to support you for the rest of your life, so tapping into it as early as age 55 may not be a good strategy. It all depends, of course, on your individual circumstances. But making a wise decision is part of maximizing your retirement readiness. And being informed about your options and their consequences is part of making a wise choice. Choose carefully!

In Part 3, we’ll talk about common rollover mistakes that can cost you big money.

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