A 401(k) rollover is the process by which you move the funds in your 401(k) to another retirement account—usually either an IRA or another 401(k). A 401(k) rollover typically happens when you leave your employer, either to retire or to start a new job. There are certain regulations you need to follow when rolling over your assets, most notably the 60-day rule. You will also need to choose a new financial institution to house your account when you roll over your money into an IRA.
If you’re considering a major move related to your retirement savings, consult a financial advisor first and talk it over.
What Is a 401(k) Rollover?
There are many ways to save for retirement, and an employer-sponsored plan like a 401(k) is one of the most common. But when you leave the employer that sponsored the 401(k), you’ll likely choose to roll over the funds from that account. You might choose to roll it into your new employer’s 401(k) plan, if one exists. You might also choose to put it into an individual retirement account (IRA), which can provide more control and flexibility.
Just like IRAs, 401(k) plans come in two forms: traditional and Roth. In most cases, someone directing a 401(k) rollover will transfer their funds to a new account that features the same tax benefits. So if you have a traditional 401(k), you’ll likely roll its assets over to a traditional IRA or 401(k). The same is generally true for Roth accounts.
IRS rules do not require you to choose the same account type. You can roll over a traditional 401(k) to a Roth IRA, but doing so triggers taxes for the current year since Roth accounts use post-tax dollars As a result, you cannot do the reverse and roll over money from a Roth 401(k) to a traditional IRA.
Direct Rollover vs. 60-Day Rollover
You can complete a 401(k) rollover in two ways: a direct rollover or a 60-day rollover. The first route transfers funds directly from one custodian to another, either electronically or via a check that you deliver to the new custodian. This type of rollover will not trigger income taxes.
You could also complete a 60-day rollover. This involves the custodian of your 401(k) making a check out to you in the amount of your account balance. Since the money will technically pass through your hands, there are some unfavorable tax implications, including a 20% tax withholding by your employer.
The IRS does not limit how much money you can transfer in a 401(k) rollover. However, certain IRA providers may have a minimum requirement for opening a new account.
How to Roll Over Your 401(k)
To roll over a 401(k) to a new traditional or Roth IRA, follow the steps below. You’ll need to choose what kind of account you want, where to open it, how you’ll transfer the funds and what investments you’ll make once the assets are available. Be sure to follow each step in order so you don’t run into any tax issues with the IRS:
1. Pick an IRA Account Type
There are two main types of IRAs that you can transfer 401(k) funds to: a traditional IRA or a Roth IRA. As we mention above, most people roll over their money into an account that has the same tax benefits as the one they’re transferring from.
For instance, let’s say you have a traditional 401(k) account that allows you to contribute money and deduct it from your taxable income, all while staving off income taxes until you withdraw in retirement. In order to maintain this tax-deferred status, you’ll need to roll your 401(k) asset over into a traditional IRA. You still have the option of rolling over to a Roth IRA, though that’ll mean you’ll pay taxes on that money for the current year.
On the flip side, those with a Roth 401(k) gain the perk of tax-free growth since the money they contribute has already had taxes paid on it. Because of this, the IRS does not allow Roth 401(k) account holders to roll funds over to anything but a Roth IRA or another Roth 401(k).
Only you can choose which type of IRA is best for your situation. If you can figure out whether your tax rate is higher now than it will be in retirement, then that should lead you in the right direction. You could also speak with a financial advisor if you have further questions.
2. Decide Where to Open Your New IRA
When opening an IRA, most people will look towards a brokerage, and for obvious reasons. 401(k) accounts typically offer a limited range of investment options. But by rolling your funds into an IRA at a brokerage, you’ll get to choose from a significantly larger pool of potential investments. Many brokerages provide access to stocks, bonds, exchange-traded funds (ETFs), mutual funds and options.
Managing retirement funds requires significant time and effort, but a financial advisor can handle this for you. Many financial advisors specialize in retirement planning and investing, which is exactly the combination you’ll need. If you go this route, your advisor will manage your investments in an IRA according to your needs and current savings situation.
If you prefer an even more hands-off approach to investing, a robo-advisor could be a good option. When you open an IRA with a robo-advisor, an asset allocation profile will be created for you based on your age, risk tolerance and proximity to retirement. The robo-advisor will then invest and manage your assets for you according to this plan.
Regardless of your choice, review any account, investment or advisory fees. An overbearing fee structure can have an extremely negative effect on your portfolio, so keep an eye out for this.
3. Initiate and Complete the 401(k) Rollover Process
Once you open your new IRA account, it’s time to begin the rollover process. The simplest way to do this is to get your 401(k) provider to complete a direct rollover from your 401(k) account right to your IRA. Each provider will have its own set of requirements for this process, so contact your plan administrator. The IRS will not charge you any taxes in this situation.
The second and less preferable option is the 60-day rollover. In this case, your 401(k) provider withdraws your 401(k) balance and gives it to you in the form of a check. Then, as you might expect, you have a 60-day window to get that money deposited in your new tax-deferred account.
However, because this situation involves money passing through your hands, the IRS stipulates that the employer must withhold 20%. That means in order to get the same amount of money into your new account that you had in your 401(k), you’ll have to use separate money to make up the difference.
Suppose you roll over $50,000 from a 401(k) to an IRA using a 60-day rollover. Your employer withholds $10,000 (20%), as required by the IRS. If you replace that $10,000 within 60 days and deposit the full amount, you report $50,000 as a nontaxable rollover and $10,000 as taxes paid. At tax time, the IRS will consider that $10,000 to be part of your federal taxes withheld, which means you’ll get it back.
Now let’s say you can’t make up that $10,000 that your employer is withholding. In this case, you deposit just $40,000 in your new tax-deferred IRA. In turn, you’ll report on your tax return $40,000 as a nontaxable rollover, $10,000 as taxable income and $10,000 as taxes paid. Because of this, you’ll lose the tax-deferred status on that money.
As you can see, it would be ideal if you could avoid the 60-day rollover and instead go with a direct rollover. But if for some reason a direct transfer can’t be made, have your plan provider send you a check made out to the custodian of your new account rather than you. This will likely let you bypass this problematic situation.
4. Start Investing With Your New IRA
Every IRA provider will have its own set of investments that it makes available to you. So hopefully during the account choosing process, you picked a brokerage that offers what you want. Once your account is open and fully funded, you can begin making investments as you see fit. Of course, if you go with a robo-advisor, this work is done for you.
In general, those close to retirement keep their investments on the safer side. This could involve investing in bonds or ETFs, both of which are typically reliable. On the other hand, someone further from retirement can afford to be riskier and more speculative. As a result, younger investors often include more stocks in their portfolio in an effort to achieve higher returns.
Rolling Over Your Old 401(k) to a New Employer
Many companies offer 401(k) plans, so people often end up having multiple 401(k)s over their years in the workforce. If you’d rather keep your funds in a single 401(k) or don’t want to open an IRA, you might have the option of transferring assets from your old 401(k) to your new one at your current job. If not, you’ll need to keep an eye on how each is performing individually.
The process for this is as simple as talking to both your current and past plan providers to make sure they will both accept a transfer of assets. While the providers can offer more specific instructions, you’ll likely use one of the methods above to complete the rollover.
Note that not all plan providers will accept employees’ past 401(k) funds as a rollover. This is because they may not be willing to add more assets to the plan, which could overwhelm it.
Tax Consequences of a 401(k) Rollover
If you handle it correctly, there are basically no tax consequences that come with a 401(k) rollover. More specifically, if you complete a direct rollover, your assets seamlessly move from one account to the other without any intervention from the IRS. A direct rollover does not appear on your tax return, and the IRS does not tax it.
Conversely, the 60-day rollover faces a few tax implications. The reason for this is despite the fact that the money will pass through your control only momentarily, the IRS views it as a potential distribution. And because the IRS offers major tax benefits with retirement accounts, it’s extremely wary of when someone makes a withdrawal, especially a large one.
To cover itself, the IRS orders employers who you take a distribution from to withhold 20%. That can be a massive amount, especially if you have a large 401(k) balance. It’s unfortunately up to you as the account holder to make up that difference before the 60-day period ends, otherwise you’ll lose the tax-deferred status for that money. Beyond that, if you’re making the distribution before age 59 ½, the IRS will hit you with a 10% early withdrawal penalty.
In today’s day and age, there’s virtually no reason a 401(k) plan provider wouldn’t have the technical capabilities to transfer your rollover funds for you. But if the 60-day rollover is unavoidable, simply ask to have the check sent to you in the name of your new account’s custodian.
Rolling Over a Roth 401(k)
Note that rolling over a Roth 401(k) has extra tax considerations if you receive matching contributions from your employer. Employer matching contributions are made on a pre-tax basis, which means they reside in a traditional 401(k). At the same time, the contributions you make exist in the same 401(k)’s Roth account. So when you initiate a rollover, these funds undergo different tax treatments.
This situation leaves you with two options: Either you can roll over the funds and place them in separate traditional and Roth IRAs, or you can include your employer contributions in your new Roth IRA. If you choose the former, you’ll have two separate accounts to manage. Choosing the latter option requires you to pay income taxes on your employer’s contributions in the current tax year.
Pros and Cons of Rolling Over Your 401(k)
A 401(k) rollover to an IRA isn’t always necessary for retirement savings. In many cases, you can keep your 401(k) even after leaving an employer. Whether a rollover makes sense depends on several factors, each with its own advantages and drawbacks.
Potential Benefits of Rolling Over
One reason to consider a rollover is the broader range of investment options available through IRAs. Many 401(k) plans offer limited selections, often centered around target-date funds. By contrast, IRAs through brokerages allow for greater diversification, including stocks, ETFs, bonds and options. Robo-advisors also offer IRA management, though investment decisions are automated.
Some brokerage firms provide incentives for opening an IRA, such as cash bonuses or enhanced account features. These perks can offer a small boost to your retirement savings, making a rollover more appealing.
Another key benefit is consolidation. Managing multiple 401(k) accounts from different employers can be cumbersome. A rollover consolidates accounts, simplifying investment tracking and strategy adjustments.
Reasons to Keep Your 401(k)
If you’re satisfied with your 401(k) provider, investment choices, and fees, a rollover may not be necessary. Sticking with your existing plan can be the simplest option if it meets your needs.
Additionally, 401(k) plans offer an early withdrawal advantage that IRAs do not. While IRA withdrawals before age 59 ½ typically incur a 10% penalty, 401(k) distributions can be taken penalty-free at age 55 under certain conditions. If you leave your job in the year you turn 55 or later, you may qualify for penalty-free withdrawals.
Evaluating Costs
Fees vary depending on your specific plan and provider. Comparing account fees, investment charges, and expense ratios will help determine whether a 401(k) or an IRA is more cost-effective in your situation.
Bottom Line
The 401(k) rollover process is fairly simple, especially if you set up an automatic transfer from your current plan. While you have to choose which type of IRA to roll your money into, the choice is usually fairly obvious based on your needs and current 401(k) arrangement. If you happen to get a direct check for your rollover, be sure to follow the IRS’ rules so you don’t incur unnecessary penalties.
Retirement Planning Tips
- Managing your retirement assets for long-term can be challenging on your own, but a financial advisor can help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Beyond your savings, your Social Security payments can help you fund your retirement. To get an idea of how much you may receive, use SmartAsset’s Social Security calculator.
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