If you have a 401(k) plan through your employer, you may have the option of rolling it over to another retirement account under certain circumstances. A 401(k) rollover typically 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,” said Jay Jumper, CEO of Future Capital, based in Chattanooga, Tennessee, in an email.
To roll over your 401(k) plan, you’ll want to do the following:
— Consider your 401(k) rollover options.
— Aim to keep costs low.
— Take care to avoid tax liabilities.
— Avoid 401(k) rollover penalties.
— Consider your investment preferences.
— Think about how soon you will need the money in your 401(k).
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 have several options. You might choose to roll over the 401(k) plan. In this case, the balance in the 401(k) plan will be moved to 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 said.
Rather than rolling over the 401(k), you could also check with your former employer to see about the possibility of leaving the funds in that account.
“Keeping your money with your old employer comes with more constraints,” said Pam Krueger, CEO and founder of Wealthramp in Tiburon, California, in an email. “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 possible option is to withdraw the money through a lump sum distribution. However, this means your money won’t have the opportunity to grow over time.
“Depending on the reasons for the distribution, there may be tax or early withdrawal penalties and the distribution itself may also be taxable,” said Allison Brecher, general counsel at New York City-based Vestwell, in an email.
[Read: How to Take Advantage of 401(k) Catch-Up Contributions.]
Aim to Keep Costs Low
Before moving funds to another account, such as an IRA, you should consider the fees associated with these different options.
“If you love the investment options in your former employer’s plan and you know you’re not paying high fees, then it’s worth comparing them against your own IRA,” Krueger said. If your 401(k) plan’s fees are higher than your own IRA’s charges, you might opt to roll over to the IRA.
Take Care to Avoid Tax Liabilities
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. Funds placed in a traditional 401(k) or traditional IRA are both pretax, 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 said.
With a Roth IRA, you will pay taxes on the contribution now, but future withdrawals are tax-free.
[New 401(k) Contribution Limits for 2024]
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, a 60-day rule applies.
“You must reinvest the distribution back into a tax-qualified account within 60 days from when your distribution check is received,” Brecher said. “Keep in mind that employers can withhold a percentage of the amount that is pending transfer to pay the income taxes due.”
If your rollover is handled correctly and within the 60-day deadline, the taxes that were withheld will be returned as a tax credit for the year when the rollover process is finished.
If you don’t follow the 60-day rule, the amount received could be subject to taxes. 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 offers limited investment choices, you may find more options available through an IRA. Consider 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 when it comes to allocating funds. If you do move the funds to an IRA, ask a financial advisor to help select investments that match your goals and risk tolerance.
“This may represent your entire life savings,” Krueger said. “You’ll want to be clear on how to properly allocate and diversify and develop sound investment strategy.”
[READ: Is a 60/40 Portfolio Appropriate for Retirees?]
Think About How Soon You Will Need the Money in Your 401(k)
Looking at your retirement plans and estimated income can help you determine what to do with your 401(k) 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 have to wait 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 can 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 a financial advisor 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. “The goal is to use this money to help you remain financially secure throughout your retirement years,” Krueger said.
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How to Roll Over Your 401(k) originally appeared on usnews.com
Update 03/11/24: This story was published at an earlier date and has been updated with new information.
