If you’ve decided to move the funds from your retirement account at your former company, you need to understand how to roll over a 401(k).
In this article, I’ll explain the steps involved to roll over your old 401(k) to an IRA or a new 401(k). I’ll also break down which of the rollover options you want and the steps you need to complete for each option.
Table of Contents
- Step 1: Decide Where You Want Your Money To Go
- Step 2: Determine the Type of Rollover You Want
- Step 3: Contact the Institution Where You Want to Open Your New Account
- Step 4: Choose Your Investments
- Frequently Asked Questions About 401(k) Rollovers
Step 1: Decide Where You Want Your Money To Go
If you leave a job where you have a 401(k), you’ve got options. Your first step is figuring out which of those options is best for you:
- Roll it into a traditional IRA
- Roll it into a Roth IRA
- Transfer it to the 401(k) plan at your new job
- Leave it in your previous company’s plan
- Cash out and transfer the money to your bank account
You can read more about those options and the reasons why you’d consider each of them. But in general, you want your retirement money in the account or plan with the lowest cost and the best investment options. And if all else is equal, it’s better to consolidate so you have fewer accounts to manage, money expert Clark Howard says.
If you decide to roll over your 401(k) to an IRA, consider the tax implications between traditional and Roth IRAs. Traditional accounts are tax-deferred, while Roth accounts involve post-tax dollars. So, among other tax-related consequences, if you roll over a traditional 401(k) to a Roth IRA, you’ll owe taxes on the full amount.
If you move your 401(k) to an IRA, you’ll also need to decide whether to manage your own investment portfolio or to invest via a robo-advisor.
Cashing out your 401(k) can be the most tempting option, not to mention the fact that it’s the option that would take the least amount of effort. But because of the tax implications, it’s a bad idea to cash out your 401(k) unless you’re in a legitimate financial crisis.
You’ll have to do the math on your own to decide which option makes the most sense for you. If you decide to move your 401(k) money into another retirement account, the information below should help streamline the process for you.
Step 2: Determine the Type of Rollover You Want
Determining the type of rollover you’ll use to transfer your funds is probably the most important step when figuring out how to roll over a 401(k).
In addition to setting the procedures you need to follow, the type of rollover you choose can lead to major financial consequences.
If at all possible, avoid what’s known as a 60-day or “indirect” rollover. But I’m getting ahead of myself.
The IRS defines three types of rollovers:
- Trustee to trustee
- Direct
- 60-day (indirect)
All three options probably involve communicating with the administrator of your previous employer’s 401(k) plan and the person who handles your new IRA or 401(k). And of course, you’ll have to fill out some paperwork.
Let’s take a closer look at each of the three rollover types.
1. Trustee to Trustee Rollovers
The IRS separates “direct” rollovers from “trustee to trustee” rollovers. But essentially, they’re both forms of direct rollovers, which is what you want.
A trustee to trustee or “in kind” rollover takes place when the administrator of your previous company’s 401(k) and the administrator or entity in charge of your new account handle the transfer electronically.
This is the easiest method because it involves minimal work on your part.
2. Direct Rollovers
As defined by the IRS, direct rollovers involve the administrator of your old 401(k) plan writing a check made payable to your new plan and sending it to you.
This method is direct because the money should never touch your bank account. Your role is to deposit that check with your IRA or with your new 401(k) plan.
However, you have just 60 days to complete the transfer to your new plan before you get penalized. So don’t stash the check somewhere and forget about it.
3. 60-Day or Indirect Rollovers
If you take anything away from this article on how to roll over your 401(k), it should be that indirect rollovers are complicated and risky.
The IRS requires your old 401(k) plan to withhold 20% of your account balance for tax purposes. So if you execute an indirect rollover, you’ll get a check or wire transfer for 80% of your account value.
But you’re still required to deposit the full 100% into your new account within 60 days. Otherwise, you’ll be hit with an additional 10% tax for early distributions of the withheld amount (the 20%).
In other words, if your old 401(k) held $100,000, your previous employer would keep $20,000 and give you $80,000. But you’d still be required to deposit a full $100,000 into your IRA or new 401(k) within 60 days.
You’d also lose the potential for tax-free or tax-deferred growth on the 20% that your old plan withheld. Plus, the withheld money (the $20,000 in our example) must be reported as income, and that could increase your tax bracket.
The IRS will refund the withheld amount (the $20,000) when you do your taxes — the following year! So if you do an indirect rollover, you’re also giving what amounts to an interest-free loan to the United States government. “The government treats you like dirt,” as Clark puts it.
The only reason to use an indirect rollover is if you have plenty of resources and moving the money between plans directly becomes too difficult. That can happen if it’s tough to track down all the people you need to complete a direct rollover.
In general, “It’s much easier procedurally to just get a check from the old plan and then deposit it into the new plan,” Clark says.
But stick to direct rollovers and fight through the red tape if you don’t fit those specific circumstances.
Step 3: Contact the Institution Where You Want To Open Your New Account
At this point, you know where you’re moving the funds from your previous employer’s 401(k). You’ve also figured out how to roll over your 401(k) through a direct rollover.
It’s time to get instructions from your new employer’s 401(k) administrator or the institution where you’re opening your IRA. They likely have some procedure for you to follow.
Here’s what you need to know:
- How should your previous 401(k) plan make out the check, or where should the wire transfer be sent?
- What forms do you need to fill out?
- What does your new 401(k) or IRA need you to relay to the administrator of your old plan?
During this step, you’ll want to be proactive, ask questions and take notes so you get the answers you need.
Old 401(k) plans and new 401(k) plans or IRAs “don’t play well together,” Clark warns. “Usually it takes a lot of work.”
Step 4: Choose Your Investments
If you’re investing your IRA through a robo-advisor, you won’t have to make many investment decisions.
You’ll fill out an initial questionnaire, which will ask you about your risk tolerance. You probably will be able to accept or reject the pre-built portfolio that the algorithm suggests for you. After that, your main job is to make regular contributions and increase your contributions over time.
If you want to manage your own investment portfolio, Clark recommends that you follow one of two options:
- Invest all your money in a target date fund
- Invest equal money in three low-cost index funds: 1) total stock market, 2) international and 3) bond index funds.
Whether you’re rolling over your 401(k) to an IRA or another 401(k), make sure that you actually invest the funds. It’s possible to complete a successful rollover only to forget about your account while your funds sit there in uninvested cash.
Frequently Asked Questions About 401(k) Rollovers
Should I Roll Over My 401(k) to an IRA?
Probably. IRAs have some advantages over 401(k) plans.
First, IRAs give you many more investment options. You can invest in specific stocks, bonds, mutual funds, ETFs and more. You can also link your IRA to a robo-advisor.
Second, there are IRA accounts that don’t charge annual management fees. Many 401(k) plans charge annual fees. So there’s a good chance you’ll be able to enjoy cost savings.
Third, tracking down an old 401(k) can be a hassle that gets more stressful the more time it has been since you worked for the company. Tracking down email addresses or phone numbers from a former company when you no longer know anyone who works there can be a challenge. Plus, the more accounts you have in different places, the more there is for you to track and manage.
However, if your old 401(k) is inexpensive and offers great investment options, you may not want or need to move it.
Can I Cash Out or Withdraw From My Old 401(k)?
Yes, you can cash out or withdraw from your old 401(k). In fact, if you have less than $5,000 in your 401(k), you may have to.
However, just because you can cash out doesn’t mean that you should.
If you’re younger than 59½ and don’t qualify for any exceptions, the IRS will penalize you 10% for withdrawing early from a tax-advantaged retirement account.
You’ll also need to pay federal income tax on the full amount that you withdraw from your old 401(k). And depending on where you live, you may need to pay state income tax as well.
You can easily end up paying 30% or more in taxes by withdrawing 401(k) money early. Plus, that money won’t continue to grow and contribute toward your retirement in the future.
Does My Rollover Count Toward My IRA Contribution?
No. The money in your old 401(k) was already subject to an annual 401(k) contribution limit.
So when you roll over that money into an IRA, it doesn’t count toward your annual contribution limit.
You can contribute additional money to your IRA on top of the money you roll over from a 401(k), up to your allowable IRA contribution limit for the year.
Do I Have a Deadline To Take Money Out of My Old 401(k)?
When you leave a job, you aren’t forced to decide what to do with your 401(k) immediately.
The money already in your 401(k) is yours, so you can usually leave it as long as you want or roll it into an IRA at any time.
However, there are a few exceptions:
- If you contributed less than $5,000 to your 401(k), your employer is legally allowed to tell you to take the money and move it elsewhere (or cash out).
- Contributions of $1,000 to $5,000 are subject to “involuntary cash-outs.” That’s when your former employer moves the full amount into an IRA. (This isn’t automatic and is at the discretion of the company.)
- If you contributed less than $1,000, your former company can mail you a check for the full amount. You can deposit this amount into another retirement account within 60 days to avoid tax penalties.
Final Thoughts
Either type of direct rollover is simpler and less anxiety-inducing than an indirect rollover. However, it does take some level of proactive effort to make a direct rollover.
Cashing out your 401(k) can be the easy route and can seem like a good idea, especially if you aren’t wealthy. Most of us, myself included, can always use extra cash. However, if you’ve decided not to leave your money in your old 401(k) plan, it’s best to marshal the discipline to complete a rollover.
