How to rollover 401(k)
Millions of Americans receive access to retirement planning through their employer-sponsored 401(k) plans. Although a powerful tool to save for retirement, it’s easy to forget when you switch jobs or retire. Scores of 401(k) plans are forgotten by Americans, with Capitalize reporting over 29 million 401(k) accounts, worth $1.65 trillion in retirement assets, being left behind as of May 2023. If you recently changed jobs or suspect you have an old 401(k) plan tucked away, figuring out what to do with it can feel overwhelming. This guide will walk you through how to rollover a 401(k), explore your best options for managing the funds, and highlight common mistakes to avoid.
What is a 401(k) rollover?
A 401(k) rollover is when you move funds from one qualified retirement plan to another, typically either a 401(k) with your new employer or a rollover IRA. In this process, you are transferring your plan assets from your previous plan account to a new retirement account. You can receive the funds in various ways, including receiving a check or having your former employer direct the plan administrator to electronically transfer the funds to your new account.
“Your best way is to do a direct rollover from the 401(k) plan custodian to another 401(k) plan custodian or an IRA custodian,” says Joel V. Russo, LUTCF®, founder and principal at NJ Retirement Planning. With a direct rollover, the plan administrator electronically transfers the funds to your new plan or IRA, or they mail you a check payable to your new choice. This helps preserve the tax-deferred status of your savings. During a direct rollover, you can transfer assets or transfer funds seamlessly between accounts, minimizing the risk of tax consequences.
When choosing an IRA custodian, it is important to select a reputable financial institution or IRA provider to ensure your retirement savings are managed securely and efficiently.
Alternatively, you can choose an indirect rollover. In this case, the plan administrator sends a check made payable to you. Unfortunately, this creates two potential side effects. You will likely incur a 20% tax hit, which is withheld in the check. Furthermore, you have 60 days to deposit the funds into your new plan or IRA. If you miss this, it’s possible that the action could be considered an early withdrawal of your retirement plan assets, which can result in additional penalties.
Best options for an old 401(k)
When deciding what to do with an old 401(k), it’s important to understand the types of plans involved, such as an employer-sponsored retirement plan or your company’s plan, as these can impact your available options and benefits.
You have four real choices to handle an old 401(k): leave it with your former employer, roll it into your new employer’s plan, roll it into a rollover IRA, or cash it out. Liquidating your 401(k) and receiving the funds is a legitimate choice, but it’s usually an unwise move that may incur a significant tax hit.
Leave it with your former employer
Not every employer allows it, but if yours does, leaving your retirement assets in your former employer’s plan is a possibility. If you like the investment options and fees, it can be a good choice.
Leaving it with your old employer does offer some unique protections that you may sacrifice if you move it to an IRA. “You lose access to the age 55 rule, which allows penalty-free withdrawals from your current employer’s plan if you separate from service (whether through retirement, layoff, or termination) during or after the year you turn 55,” says Nicole E. Asher, CFP®, CPWA®, ChFC®, senior vice president, senior wealth management advisor at Greenleaf Trust.
Asher also notes that enhanced creditor protections are available for 401(k) plans compared to lower protections in IRAs. However, keeping the 401(k) at your former employer means you can no longer contribute to the plan, and they may increase fees and/or limit your investment choices. Additionally, you may face fewer investment options in your former employer’s plan, which could restrict your ability to diversify or manage costs.
Roll it into your new employer’s 401(k)
If you value simplicity, rolling over your 401(k) to your new employer’s plan may be a wise decision. This allows you to enjoy the same protections available in keeping the assets with your old employer. It also allows you to streamline your retirement planning by not having multiple plans to manage. Additionally, earnings will be tax-deferred, and there are typically no penalties for making the move.
One drawback to consider is that the new employer’s plan may not be as robust, and it may be more expensive due to higher investment fees or administrative costs. Some employer-sponsored plans have limited investment options, which can lead to higher expense ratios or fewer low-cost funds compared to other alternatives like a rollover IRA. Additionally, smaller or less established plans might charge higher fees to cover plan administration, which can eat into your retirement savings over time. It’s important to carefully review the fee structure and investment choices of your new employer’s retirement plan before deciding to roll over your 401(k) to ensure it aligns with your financial goals and helps your savings grow tax-deferred.
Roll it into an IRA
Rolling an old 401(k) into an IRA can be a good way to enhance your retirement planning. An IRA, or individual retirement account, is a type of retirement savings account that offers increased control over your investments and potential cost savings. Most 401(k) plans offer only a dozen or two investment options. A rollover IRA increases the options exponentially, potentially to thousands of choices. This expanded universe includes investment products such as mutual funds, which allow for diversification, reinvestment, and growth through compounding. “This expanded universe allows you to fine-tune your portfolio allocation, access specialized investment strategies, and potentially find lower-cost alternatives to expensive 401(k) options,” notes Asher.
If you have a traditional 401(k) plan, it’s possible to convert it to a Roth IRA after a rollover. This provides tax-free withdrawals in retirement, but you will likely face taxable consequences in the current tax year, so you must keep that in mind.
What are the disadvantages of rolling over a 401(k) to an IRA? The process does introduce potential problems. You lose loan availability and many of the protections found in a 401(k). For those considering early withdrawals, IRAs allow for penalty-free distributions under certain IRS rules, such as substantially equal periodic payments, which can be used for retirement income planning. Finally, if you move the 401(k) to a traditional rollover IRA, you must take required minimum distributions (RMDs) once you reach age 73.
How to rollover an old 401(k)
There are specific steps to follow if you decide to roll over your old 401(k). Don’t let them overwhelm you, though, as they’re not difficult, just precise.
Here’s how to rollover a 401(k).
Decide what you want: You must first choose which action you want to take – leave it with your former employer, take it to your new job, or roll it into an IRA. Don’t overlook investment options, fees, your investment strategy, and investment decisions when analyzing your choices.
Begin the rollover: Contact the administrator of the old plan and the new administrator or brokerage firm to determine what’s necessary to initiate the process. You will likely need to complete paperwork to start the process.
Make sure everything is correct: A lot can go wrong when rolling over a 401(k). You may miss beneficiary designations or errantly open the wrong account. Missing something can delay processing time.
Request a direct transfer: Receiving a check is possible, but it can present problems. Request a direct transfer if possible. This helps avoid unnecessary tax situations. If you do receive a check made out to the new administrator or brokerage, send it to them ASAP.
Wait: Even if the old administrator electronically sends the funds, it won’t happen overnight. “If you have not received any communication or received the rollover funds within two weeks, you should proactively follow up and track the progress of the rollover,” says Asher.
Once the funds are deposited into your new 401(k) or IRA, invest the funds. If you need help with retirement planning, consider consulting a trusted financial advisor to formulate a strategy.
Factors to consider before making a decision
There’s a lot to keep in mind when asking yourself, “Should I roll over my 401(k)?” Making the wrong choice can be costly or could make achieving retirement goals needlessly challenging. Here are several key factors to consider when assessing the available choices.
Fees: Fees are a common part of investing. Paying too much can erode a portfolio over time. For example, just a 0.75% difference (i.e., paying 1.00% vs. paying 0.25% in fees) can reduce the value of a $100,000 portfolio by $30,000 over the course of 20 years, according to the SEC.
Company stock: Do you hold company stock in your 401(k)? You may encounter Net Unrealized Appreciation (NUA), which represents the difference between the current market value of the shares and their cost basis. Various tax implications may arise when you transfer the shares. “Make sure not to co-mingle company stock if it’s applicable and whether NUA is useful,” advises Russo. Speaking with a tax advisor may be beneficial if you have questions.
Your specific situation: While there are a lot of truisms, retirement planning isn’t a one-size-fits-all approach. It’s best to analyze your specific situation to determine what’s best for you. Speaking with a financial advisor can be a good way to help, and some employers may even offer access to one through your group benefits.
Possible Roth IRA conversions: Just because your funds are in a traditional 401(k) doesn’t mean you’re unable to convert them to a Roth IRA. A conversion may benefit you if you believe tax rates will be higher in the future or you want to reduce future RMDs. The conversion will trigger a taxable event, though, as the amount converted counts as ordinary income, possibly putting you in a higher tax bracket for the year. Converted amounts are subject to ordinary income taxes, which should be considered when planning a conversion. It’s also possible to do partial conversions over several years to soften the blow.
Having an investing strategy in place will help guide decisions on these and other factors.
Common mistakes to avoid when rolling over an old 401(k)
You don’t want to commit a mistake that can hinder your retirement plans. Due diligence is essential to avoid pitfalls when deciding to roll over your 401(k). These are some common mistakes you want to avoid when moving your retirement plan.
Opting for an indirect rollover: Direct rollovers are usually best as they avoid taxable situations, but it’s easy to select an indirect rollover. “One of the most costly errors that individuals make is choosing an indirect rollover instead of a direct rollover. When you request that a check be mailed to you rather than sent directly to your new IRA custodian, your former employer may be required to withhold 20% for federal taxes, treating this as a taxable distribution,” says Asher.
Not investing the funds: Plan administrators commonly liquidate your holdings and transfer cash to your new plan or IRA. Don’t let the funds sit there uninvested. Once you have the funds in your new retirement account, invest them.
Missing the 60-day window: Regulation requires the deposit of 401(k) funds within 60 days of getting distributed funds. Missing that can be problematic. “Missing the 60-day deadline is another critical mistake that can have severe consequences. If you fail to complete the rollover within this timeframe, the entire distribution becomes immediately taxable and may also be subject to the 10% early withdrawal penalty if you are under age 59½,” notes Asher.
Opening the wrong account type: Selecting the incorrect account can lead to tax issues. If you have a traditional 401(k), it must go into a traditional rollover 401(k). Putting funds from a Roth 401(k), for example, into a traditional rollover 401(k) can create tax problems.
Overlooking old 401(k) plans: It’s possible that you may have more than one old 401(k) plan that you may have forgotten about. Now’s the time to learn if you do. The Employee Benefits Security Administration has a helpful tool to locate 401(k) plans you may have out there. If you locate any, consider consolidating them into a rollover IRA with an online brokerage.
Bottom line
Rolling over an old 401(k) doesn’t have to be scary. When done wisely, it can go a long way in helping to amplify your retirement planning efforts. Select an option that works best for you and diligently process the transaction. Consider all your options and select the best one to support your savings efforts.
