401(k) Rollover: What You Need to Know

Changing jobs or entering a new phase of life? Don’t forget about your old 401(k) rollover! It is a smart move to keep your retirement savings growing and accessible.

Whether you are eyeing more investment options, better account control, or simpler management, a 401(k) rollover can help you take charge of your retirement planning.

This guide walks you through how a rollover works, how to avoid common mistakes, and whether 401 (K) rolling over to an IRA is right for you.

What Is a 401(k) Rollover?

When you transfer your 401(k) retirement money into a new plan or an IRA, it is called a 410(k) rollover. From the date you receive your retirement plan distribution or IRA, you have 60 days to roll it over to another plan or IRA.

One rollover per 12-month period is allowed from the same IRA. However, this rule doesn’t apply to plan-to-plan rollovers and some other types of rollovers.

Overview: How to Start Your 401(k) Rollover?

1. Determine What Type of Account You Want

Decide whether you are going to make your own investment choices or need an advisor to make the choices for you. Also, you need to decide whether you want more investment options.

If you want to deposit the funds in an IRA bank account, compare IRA savings accounts and IRA CDs to find the best fit. If you are below age 59 ½, making a withdrawal from your traditional IRAs will incur a 10% early withdrawal penalty. If you want to save money at a fixed rate, unexposed to the market volatility, then an IRA CD may be a good option.

It will also protect you from the Federal Deposit Insurance Corp. (FDIC) or the National Credit Union Administration (NCUA). However, make sure that all your IRA CDs and savings accounts are within insurance limits and are backed by the FDIC.

Key Takeaway:

While making the decision, factor in your age and risk tolerance level.

2. Open Your Account Through the Right Institution

If the company where you hold your 401(k) is sending a check, your IRA institution may need the check to be written a certain way with the IRA account number on it.

Key Takeaway:

By following your IRA institution’s instructions carefully, you can avoid complications. Your 401(k) company can wire the funds to the IRA institution. So, make sure to check your options for rolling your 401(k) into an IRA. Don’t forget to check whether there are fees associated with the rollover.

3. Decide the Procedure to Initiate the Rollover Process

Once the IRA is set up, you may be asked to contact your 401(k) administrator. You probably should choose a direct rollover.

Key Takeaway:

When you do a direct IRA rollover, the 401(k) funds are sent directly into the IRA without you touching the funds. A cheque made payable to you triggers the 20% tax withholding. If you don’t want this to happen, then make sure you specify that you want a direct rollover.

4. Keep Note of the 60-Day Rule

From the date you receive your retirement plan distribution, you have 60 days to deposit into a qualified account; if you fail to follow the 60-day rule, the rollover becomes a taxable event. Your 401(k) institution may:

• Send a check to you or the institution where you are opening your IRA.
• Digitally transfer the money to be rolled over via wire transfer.

Key Takeaway: If 20% of the rollover amount is withheld for taxes, you have to add funds in order to roll over the full amount.

Considerations for an Old 401(k)

If you have a 401(k) with a former employer, you have 4 options. Your 401(k) could be a big chunk of your retirement savings. Therefore, it’s important to compare the pros and cons of each of these options to find the right one for you. Here are the 4 options you can consider:

1. Keep Your 401(k) as it is With Your Old Employer

Most companies allow their employees to keep their retirement savings in their plans even after they leave.

Some benefits are:

• Your money grows tax-deferred.
• You can withdraw without any penalty if you leave your job at age 55 or older.
• Your 401(k) may be low-cost and offer unique investment options.
• Federal law offers protection against creditors.

Some disadvantages are:

• If the money in your 401(k) is less than $5,000, it will be automatically sent to your IRA or you.
• If you decide to keep the money with your former employer, you don’t have the option to add more money to the account or take a 401(k) loan.
• You may have limited withdrawal options. For example, partial withdrawal may not be allowed. If you have to withdraw, you need to withdraw the entire amount.
• After you reach age 72½, you must take your annual required minimum distributions (RMDs) from your traditional 401(k).

That said, if you hold high-value company stock in your workplace savings account, you must consider the potential impact on net unrealized appreciation (NUA) before you do the rollover or an alternative.

2. Roll Over the Money Into a New Employer’s Plan

Check with your new employer if they accept a rollover from a previous employer’s plan.

The benefits of rolling over your money from an old employer’s plan into a new employer’s plan are:

• Your money continues to grow tax-deferred.
• Easier to manage your retirement savings with only one 401(k).
• Many plans offer low-cost or plan-specific investment options.
• Federal law provides broad protection against creditors.
• You don’t have to take RMDs even if you’re still working after age 72½.

Some disadvantages are:

• You need to ensure that you understand the rules of your new plan. Otherwise, you might incur some losses.
• Take into consideration the investment range available in the new plan.

3. Rollover Into an IRA

A rollover IRA allows you to transfer money from your former employer-sponsored retirement plan into an IRA. A bank or a brokerage firm can open an IRA for you. Ensure that you understand the fee structure and associated expenses before you choose your IRA provider.

Some benefits of choosing a rollover IRA are:

• Your money continues to grow tax-deferred.
• If you are under 59½ years of age, you are allowed to make a penalty-free withdrawal for qualifying higher education expenses or a first-time home purchase.
• You get a broader range of investment choices than what is available in an employer-sponsored 401(k).

Some disadvantages are:

• After you reach age72½, you must take annual required minimum distributions (RMDs) from a traditional IRA every year, even if you are still working. A Roth IRA is exempted from this rule.
• Federal law offers broader protection for retirement savings in 401(k) plans than in IRAs. However, there are a few states that provide certain creditor protection for IRAs, too.
• For the calendar year 2020, the CARES Act temporarily waives required minimum distributions (RMDs) for all types of retirement plans (including 401(k)s, IRAs, 457(b)s, 403(b)s, and inherited IRA plans. This includes the first RMD (that may have been delayed from 2019 until April 1, 2020).

Rollover Your 401(k) to a Traditional IRA

Traditional IRAs are tax-deferred retirement accounts. If you are retiring or changing jobs, a 401(k) rollover to a traditional IRA will give you more flexibility in managing your savings.

Pros:

• Your money grows tax-deferred.
• You have access to a wide range of investment options that are not available in your former employer’s 401(k) or a new employer’s plan.
• You can consolidate multiple retirement accounts into a single IRA to simplify tracking and management.
• You may get some additional services, such as guidance and investing tools, from your IRA provider.

Cons:

• You can’t borrow from your IRA as you can with a 401(k).
• Your IRA provider may charge you annual fees, maintenance fees, or higher investment fees.
• The expenses can be higher than with a 401(k).
• Some investments offered in a 401(k) plan may not be available in an IRA.
• Usually, only in the case of bankruptcy are your IRA assets protected from creditors.
• If you have company stock, rolling over may have negative tax implications.
• You have to take RMDs from your traditional IRAs, regardless of whether you’re still working at age 72 (70½ if turning 70½ in 2019 or earlier).

Read more about Traditional IRA

Rollover Your 401(k) to a Roth IRA

If you are transitioning to a new job or heading into retirement, you can convert your 401(k) to a Roth IRA. This can help you continue to save for retirement while allowing your earnings to grow tax-free.

Pros:

• You can roll Roth 401(k) contributions and earnings directly into a Roth IRA.
• You do not have to take RMDs.
• Additional contributions and earnings can grow tax-free.
• You may receive additional services from your IRA providers, such as investing tools and guidance.
• You have a vast range of investment choices that were not available in your former employer’s 401(k).
• You can consolidate multiple retirement accounts into a single Roth IRA to simplify tracking and management.

Cons:

• You can’t borrow against a Roth IRA as you can with a 401(k).
• You may have to pay annual fees. Some companies may charge you fees for maintaining your Roth IRA.
• You may also face higher pricing, expenses, and investing fees than you would with a 401(k).
• Rollover of traditional 401(k) assets into a Roth IRA is taxable during conversion.
• Some investment options available in a 401(k) plan may not be available in a Roth IRA.
• Rolling over company stock may have negative tax implications.
• Your IRA assets are protected from creditors, usually only in the case of bankruptcy.

Read more about the Roth IRA

Cash Out Your 401(k): Pros and Cons

Although cashing out of retirement accounts is an option, it should be avoided unless you need immediate cash, and you have no other option to meet this need. The consequences of cashing out depend on your tax situation and age.

If you take the money from your 401(k) before you reach age 59½, the withdrawal is subject to income taxes and also a 10% early withdrawal penalty. However, suppose you weren’t employed with your former employer in or after the year you reached age 55 but are not yet age 59½. In that case, the early withdrawal penalty doesn’t apply.

That said, this exception is not for assets rolled over to an IRA. A $50,000 cash-out before age 59½ could cost $20,500 in penalties and taxes.

Note: Make an informed decision about the options: Find out the 401(k) rules, compare expenses and fees, and factor in the potential tax impact.

Pros

• Immediate access to your money
• Useful in emergencies

Cons

• Subject to income tax and a 10% early withdrawal penalty (if under age 59½)
• Permanent loss of retirement savings growth
• Risk of reducing long-term retirement readiness

Benefits of Rolling Over Your 401(k)

• You Can Consolidate Your Multiple 401(k) Accounts Into One IRA

  You may have multiple 401(k)s with various employers if you change jobs often. The more accounts, the more challenging it is to manage these accounts. Rolling over all your 401(k)s into one IRA can make it simple for you to track and manage your retirement savings.

• You Have More Investment Choices

  You may have very limited investment choices with a 401(k). But, an IRA offers a diverse range of items to invest in, including bonds, individual stocks, or other vehicles that may not be available in your 401(k).

  You can’t add any contribution to the 401(k) held at your previous employer. But if you perform a rollover into a traditional IRA, you can contribute to the conventional IRA. However, you have to adhere to the annual IRA contribution guidelines.

• You Can Potentially Increase Your Wealth

  You are probably already working with a financial adviser or financial planner, or have a brokerage where part of your money is managed. These are good reasons for you to roll over your 401(k) because, with the help and guidance of these experts, you can take your account wherever you want and see your wealth grow.

Reasons You May Choose Not to Rollover Your 401(k)

1. You Like Your Existing 401(k)If your current 401(k) is in a low-fee environment, you may want to remain invested in it. Moreover, if you like the investment options your 401(k) offers, you have another reason to stay with your employer’s 401(k) plan. But compare the fee structure to the costs and benefits you would have with having your money in an IRA.
2. The 401(k) Retirement Account May Offer Benefits That an IRA Doesn’tIf you stay with your 401(k), you will be able to access the money when you are 55 without the penalty of 10% charged for early withdrawal. This 10% early withdrawal penalty can be avoided if the distributions are made after you leave your employer, and the separation occurred in or after the year you turned age 55. You cannot prevent the 10% penalty when you withdraw from your IRA before age 59½.
3. You Can Postpone Required Minimum Distributions (RMDs) With a 401(k)You need to start taking an RMD the year you retire or the year you turn age 72½. So, if you are still working at that age and if your money is in a 401(k), you may be able to postpone some of your RMDs.
4. You Can’t Borrow From Your IRAOnce you roll over your 401(k) to an IRA, you will not have the option to take a 401(k) loan. Although it is not recommended to take a loan from your retirement funds, it may be a great option to have in case of a short-term crunch or emergency.

401(k) Rollover Mistakes to Avoid

1. Not Rolling Into the Right IRARolling into a Traditional or Roth IRA without understanding the tax implications can lead to surprise bills.
2. Getting a Check in Your NameIf the check is made out to you instead of the new custodian, it’s treated as a distribution and taxed.
3. Letting the Rollover StallSometimes rollovers are delayed, and if you miss the 60-day window, you may owe taxes and penalties.
4. Not Investing Your Rollover FundsOnce rolled over, make sure the money is reinvested. Don’t let it sit idle in a cash account.

Is it Better to Roll over a 401(k) to an IRA?

If you like the investment options and the expense ratios on the investment of your employer-sponsored 401(k) plan, then you don’t need to roll it over to an IRA. That said, rolling over your 401(k) to an IRA allows you to have a vast range of investment options.

While a typical 401(k) plan has around 20 to 40 mutual funds available, an IRA allows you to access thousands of exchange-traded funds (ETFs) and mutual funds, confirms Kaleb Paddock, a certified financial planner at Ten Talents Financial Planning in Parker, Colorado.

Also, a rollover from your 401(k) to an IRA can help you earn a brokerage account bonus based on the rules and regulations set by the brokerage. Another reason you consider rolling your 401(k) to an IRA is that you can invest in socially responsible funds that may not be available with a 401(k).

Once you rollover to one of these large IRA custodians, you have access to these socially responsible funds. Compare the fees associated and the expense ratios of both these retirement accounts, and then decide whether rolling over your 401(k) is a better option or not.

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Do You Have to Pay Taxes When Rolling Over a 401(k)?

If you manage to roll over your 401(k) into another plan or an IRA within 60 days from the date you receive your retirement plan distribution, you are not taxed. A direct rollover is another method used to roll over your 401(k).

FAQs

Can I leave a portion of my 401(k) in an old employer’s plan and roll the rest into an IRA?

Yes, if your plan allows partial distributions. But most people choose to consolidate for simplicity.

Can I roll over my 401(k) while still working?

Some plans allow in-service rollovers, but it depends on the employer’s policy.

Can I roll over a 401(k) with both pre-tax and after-tax money?

Yes, but you must track both types separately. Pre-tax money goes to a Traditional IRA; after-tax money can go to a Roth IRA.

What is a rollover IRA?

It’s a type of IRA designed to hold funds rolled over from a 401(k) or other qualified plan.

How long do I have to roll over a 401(k) after leaving a job?

You typically have 60 days to roll over to a 401(K) after leaving your job to avoid taxes and penalties.

How do I rollover a 401(k) from one company to another?

Request a direct rollover with your plan administrator and provide details of your new plan.

How can I roll over a 401(k) without penalty?

Always opt for a direct rollover to avoid early withdrawal penalties and tax liabilities.

Can I roll over a 401(k) myself?

Yes, but it’s easier (and safer) to work with a plan administrator or retirement specialist.

Rolling over your 401(k) can help you simplify, grow, and take full control of your retirement savings if you do it right. Whether you are transferring to an IRA, a new plan, or considering a Roth conversion, understanding your options is key. Make informed decisions today, and your future self will thank you.