If you have a 401(k) plan through your employer, there are certain times when you may have the option of rolling it over to another account. A 401(k) rollover typically refers to moving your funds into a different retirement account. The transfer usually occurs when you leave a job or transition into retirement. “Rollovers can be simple if you prepare for the process ahead of time and learn what to look for and how it’s done,” says Jay Jumper, CEO of Future Capital based in Chattanooga, Tennessee.
To rollover your 401(k) plan, you’ll want to:
— Understand your 401(k) rollover options.
— Look at the costs and features of different accounts.
— Take care to avoid taxes on the transaction.
— Roll over directly to avoid penalties.
— Evaluate your investment choices.
— Think about when you will need to access the funds.
Gaining insight into the process and considering your lifestyle and plans can be helpful before moving funds. Read on to learn the steps involved in a 401(k) rollover.
Consider Your 401(k) Rollover Options
If you’re leaving your current workplace and have a 401(k) plan with the company, you’ll typically face several choices related to the account. You might choose to rollover the 401(k) plan. In this case, the balance in the 401(k) plan will be moved to a new account. This new account might be a 401(k) plan at your new employer or an individual retirement account. “While an old 401(k) can sometimes be rolled over into your 401(k) with a new employer, the most common course of action is to transfer those funds into an IRA,” Jumper says.
Rather than rolling over the 401(k), you could also check with the organization you’re leaving to see about the possibility of not moving the account. Sometimes employees are able to leave the funds in the account with the former employer. “Keeping your money with your old employer comes with more constraints,” says Pam Krueger, CEO and founder of Wealthramp in Tiburon, California. “You have limited investment options, less control over costs and you have to follow plan rules. Plus, it’s another account to keep up with.”
Another option consists of a lump sum distribution, which refers to taking the money out. You’ll typically lose the opportunity for funds to grow over time. If you have a check made payable to you, “you’ll get charged with the mandatory 20% withholding tax,” says Paul Sundin, a CPA and tax strategist at Emparion in Chandler, Arizona.
Aim for Low Costs
Before moving funds to another account such as an IRA, you’ll want to look at the fees charged by your current 401(k) plan and any costs related to the IRA. Compare the fees to understand if the new account’s charges will be higher or lower than your current 401(k) plan.
Take Care to Avoid Taxes
You’ll want to be aware of the potential tax implications of transferring funds to a traditional IRA or a Roth IRA. Choosing to roll a traditional 401(k) over to a traditional IRA can be done without incurring taxes. The funds placed in a traditional 401(k) or traditional IRA are both pre-tax, which means the money won’t be taxed until you take a distribution. “If you do a rollover to a Roth IRA, you will owe tax on the rolled over amount right away,” Jumper says. With a Roth IRA, you will pay taxes on the contribution now, but the future withdrawals are often tax-free.
Avoid 401(k) Rollover Penalties
If you decide to roll over your 401(k), your plan sponsor may directly transfer the money to your new account, which can be done without incurring penalties or taxes. The plan sponsor could also mail you a check directly. When a check is sent to you, it will arrive with a 60-day rule. “You have 60 days to deposit it into a qualified account, or it will incur taxes,” Sundin says. You might also face an early withdrawal penalty if you are not at least 59 1/2 years old.
Consider Your Investment Preferences
If your 401(k) plan only offers several investment choices, you may find more options available through an IRA. “Choosing to invest in an IRA can come with some great perks over a 401(k), including a more diverse selection of funds to invest in,” Jumper says. You might decide to place funds into different types of investments in the IRA, such as stocks, bonds, exchange-traded funds and mutual funds.
Before deciding what to do with your 401(k) funds, you’ll also want to review how you plan to manage investments. If you leave the 401(k) with your former employer, you may be on your own for allocating funds. If you move the funds to an IRA, you could ask a financial advisor to help you select investments that fit your goals and risk tolerance. “This may represent your entire life savings,” Krueger says. “You’ll want to be clear on how to properly allocate and diversify and develop sound investment strategy.”
Think About How Soon You Will Need the Money in Your 401(k)
Looking at your plans for retirement and the income you will need can help determine what to do with your 401(k) plan when leaving a job. If you leave your job at age 55 or older, you can take 401(k) withdrawals without penalty from the account at that job. If you roll a 401(k) balance over to a traditional IRA, you’ll need to keep the amount in the account until you are at least 59 1/2 years old to avoid a 10% early withdrawal penalty. Transferring funds to a Roth IRA has different implications. While you’ll be able to withdraw the contributions made to a Roth IRA at any time, you’ll need to wait at least five years to withdraw any earnings from the account without penalty.
Before carrying out a 401(k) rollover, it may be helpful to talk to your family and other advisors or mentors about your future plans. Think about when you’ll want to retire, what type of lifestyle you want to lead during retirement and other activities or hobbies you may be interested in pursuing later on. “The goal is to use this money to help you remain financially secure throughout your retirement years,” Krueger says. Lining up current funds, savings strategies and expected distributions with your life aims can guide your 401(k) rollover decision.
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Update 03/24/21: This story was published at an earlier date and has been updated with new information.