Changing Jobs: What About 401(k)?
Question: I am leaving my job at a company where I have a 401(k) account and will be joining one where I won’t be eligible to contribute to a 401(k) plan for a year. What should I do with my existing account? Should I roll it over to an individual retirement account and then into my new employer’s 401(k) when I am eligible? --P.S .
Answer: You may certainly have your 401(k) account transferred to a separate rollover IRA. But be careful. Under rules that took effect in January, 1993, taxpayers cashing out of their old employers’ 401(k) or other qualified pension plans will be slapped with a 20% withholding tax on the disbursement if they take possession of the money rather than have it transferred directly to a qualified employer pension plan or an IRA.
You may transfer the funds later from that IRA into a 401(k) account with your new employer.
Be aware that federal rules require that you withdraw the after-tax contributions you made to the 401(k) before you transfer the remainder of the account to an IRA. There is no penalty for this distribution because you already paid tax on the money before you put it into the 401(k) account. Your employer is required to keep records distinguishing your before- and after-tax contributions.
There may be an easier choice, though: leaving your account with your old employer the way it is. Under federal law, an employer cannot force you to withdraw money from your account without your permission, unless the account contains less than $3,500 or the employee has reached the retirement age specified in the company’s 401(k) rules.
The $3,500 rule includes both employee contributions and any matching funds contributed by the employer. Of course, once you leave, neither you nor the previous employer will be making contributions, but the account will continue to accumulate tax-deferred interest. Later, when you are eligible to join your new employer’s 401(k) plan, you can transfer your old account.
One more bit of advice: If you decide to leave your 401(k) with your previous employer, be sure to check the plan’s rules to determine the terms for reclaiming your money in the future. You do not want to give up easy access to your funds, especially because you are severing your relationship with your employer.
Because readers ask so many questions so often about 401(k) plans, we have prepared a special pamphlet addressing some of those questions. To order a copy, send a check for $5.41 (includes tax and postage) to Times on Demand Publications, P.O. Box 60395, Los Angeles, CA 90060. Make checks payable to the Los Angeles Times. Please allow six to eight weeks for delivery.
IRA Contributions for Married Couples
Q. Will you please explain the rules for contributions by married couples to individual retirement accounts?
C.F.
A. Couples in which both spouses are working may contribute up to $4,000 a year into their IRAs. If one of the spouses works part time, he or she may contribute up to $2,000 in earnings a year. (For example, if a spouse earns a total of $1,850 in the year working as a child-care provider or free-lance writer, all those earnings may be put into an IRA.)
If one of the spouses is not employed, the maximum contribution is $2,250 a year. A couple’s contribution of $2,250 may be divided between the accounts of the two spouses any way the couple chooses. It does not have to be split along the lines of $2,000 for the spouse who is employed and $250 for the spouse who is not. However, when both spouses are employed, each spouse must keep separate IRAs.
That said, let’s address the question of whether these IRA contributions are tax-deductible. If you are not covered by a qualified pension plan through your employer, you are entitled to make a tax-deductible contribution to an IRA under any circumstances.
If you are an “active participant” in a qualified pension plan, such as a 401(k), you are still allowed to have an IRA, but your contribution to it will be tax-deductible only if you meet specific income limits. Couples filing a joint return are entitled to a fully deductible IRA contribution if their adjusted gross income does not exceed $40,000. The deduction decreases gradually, ending at an adjusted gross income of $50,000.
Individuals with an adjusted gross income of less than $25,000 are entitled to a fully deductible IRA. The deduction gradually declines, ending at an adjusted gross income of $35,000.
Even if your IRA contribution is not tax-deductible, its earnings are not taxed until they are withdrawn. Assuming a 10% rate of return, the benefits of compound interest will turn a $2,000-a-year contribution into $114,550 in 20 years and into nearly $329,000 in 30 years.
By the way, whether your IRA is tax-deductible is entirely separate from how much a couple may contribute into these accounts. A couple in which only one spouse is employed is entitled to a maximum IRA contribution of $2,250 regardless of whether the contribution is tax-deductible. The fact that the contribution is not tax-deductible does not mean an unemployed spouse is entitled to make a full $2,000 contribution.
Mother’s Death Complicates Sale
Q. My mother sold her home but died before escrow closed. When it did close, my brother and I (my mother’s only two heirs) shared the proceeds equally. How should this sale be reported to the IRS?-- W.D.B .
A. The sale should be reported on the income tax return filed by your mother’s estate, if there is one. (This is not your mother’s final income tax return, but any return filed by the estate.) If the estate is not large enough to require an income tax return, you and your brother should each report your share of the proceeds on your individual returns.
By the way, the proceeds you receive from the sale are not taxable, because the property would have been given a full step up in value upon your mother’s death, eliminating any taxable gain to you and your brother.
