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401(k) Rollover vs. IRA Rollover


When you change employers, you may be required to roll over your 401(k) funds from that employer to another retirement account to avoid any tax penalties. The two most popular rollover options are to roll your funds into a new 401(k) or an individual retirement account (IRA). While you might be restricted based on your new 401(k) account, both can be great options. Here is what you need to know.

A financial advisor can help you create a retirement plan and advise you on 401(k) rollovers for your specific needs.

What Is a 401(k) Rollover?

The term 401(k) rollover refers to the transfer of funds from an old employer-sponsored retirement account to a new one. This process is often initiated when an individual changes jobs and wishes to consolidate their retirement savings into a single account, as opposed to leaving them scattered across accounts sponsored by previous employers. Sometimes, the term “401(k) rollover” is used to describe a transfer of funds from a 401(k) to any other retirement account and sometimes it refers to rolling 401(k) funds over to another 401(k).

There are two major forms of 401(k) rollovers, and the choice between them is typically dictated by employment circumstances and personal investment preferences. The first type is the direct rollover or 401(k) to 401(k) rollover, where retirement savings are transferred directly from your old employer’s 401(k) plan to a new one. The second type is the 401(k) to IRA rollover, where retirement savings from your old employer’s 401(k) plan are moved to an individual retirement account (IRA).

The steps involved in performing a 401(k) rollover typically include deciding which type of rollover suits your needs, choosing the right 401(k) or IRA provider, and initiating the transfer of your funds. Each type of rollover has its unique advantages, and the choice between them is contingent on individual financial circumstances, retirement goals and investment preferences.

401(k) Rollover Options

Several options are available when contemplating a 401(k) rollover. These include:

1. Cashing out your 401(k)
2. Leaving the funds in your old 401(k)
3. Transferring to a new 401(k)
4. Rolling over into an individual retirement account (IRA)

Each of these options comes with its own advantages and disadvantages and is suited to different financial circumstances and goals:

1. Cash Out Your 401(k)

As we delve into the specifics, the first option to consider is cashing out your 401(k). This option refers to the act of withdrawing all the funds from the account. It might be an attractive choice for individuals who find themselves in immediate need of funds. However, it’s important to note that cashing out a 401(k) can come with significant tax implications and penalties, especially if the withdrawal is made before the age of 59 1/2.

To mitigate any drawbacks, one could consider setting aside money to cover potential tax liabilities. In addition, this option might be considered in situations where immediate financial needs outweigh the potential long-term benefits of keeping the money in a retirement account.

2. Leave Money in Your Old 401(k)

Another alternative to consider is leaving your money in your old 401(k). This means maintaining the status quo with the existing investment options and fees. This choice might be preferable if the individual is satisfied with the current plan or prefers to defer the decision until a later date.

This may be your case if you have a 401(k) with a former employer that offers a unique investment option not available in other retirement accounts. However, you may also have less control of the account and face potential fees for account maintenance.

3. Roll Over Your Money to a New 401(k)

Rolling over to a new 401(k) involves transferring the funds from the old 401(k) to a new one, typically offered by a new employer. This option can be advantageous if the new plan offers better investment options or lower fees, and it allows for consolidated management of retirement savings.

A side-by-side comparison of a new 401(k) plan with other options, including the old 401(k) and an IRA, can help illustrate the potential benefits and drawbacks. It’s also important to understand how to evaluate a new 401(k) plan, such as what to look for in investment options and fees.

4. Roll Over Your Money Into an IRA

A roll over to an IRA involves transferring funds from the 401(k) to an IRA, which typically offers a wider range of investment options than a 401(k).

A checklist could be useful for evaluating an IRA, considering factors such as investment options, fees and tax implications. While an IRA can offer greater flexibility and potential tax advantages, it’s also important to understand the restrictions on contributions and potential fees for account management.

Pros and Cons of a 401(k) Rollover

A couple considering the advantages and drawbacks of rolling over their 401(k).

By moving your 401(k) to a new account, you could unlock different investment options than those available in your previous plan. For example, your old plan might have a specific set of mutual funds, while your new plan or IRA could have other investments including individual stocks, bonds and ETFs.

This diversification can potentially enhance your portfolio, possibly leading to higher returns over time. However, remember that while the potential for higher returns exists, it is not a guaranteed outcome. A rollover also simplifies the management of multiple 401(k) accounts, making it easier to oversee your retirement savings, streamline your retirement planning process and monitor your investment performance more closely.

It’s also crucial to be aware that a 401(k) rollover can have potential pitfalls. A notable one is the risk of financial penalties if the rollover isn’t executed correctly. For example, if you receive a check from your old 401(k) and don’t transfer it into a new retirement account within 60 days, you might find yourself facing taxes and early withdrawal penalties. This could significantly diminish the amount you eventually have for retirement. Also, there may be tax implications if the rollover isn’t conducted from a traditional 401(k) to another traditional account or from a Roth 401(k) to another Roth account.

Pros and Cons of an IRA Rollover

The main advantage of an IRA rollover is the access it provides to a wider range of investment options, from individual stocks and bonds to mutual funds, thereby offering investors more flexibility in shaping their portfolios. Additionally, an IRA rollover can confer potential tax benefits.

However, potential downsides to an IRA rollover should also be evaluated. The process could involve fees or penalties, such as surrender charges on annuities or exit fees from previous retirement plans. Furthermore, the rollover process can be complex, making it necessary to carefully review the associated rules and regulations. Moreover, depending on an individual’s tax situation, there might be significant tax consequences, including possible immediate taxes levied on the transferred pre-tax dollars.

Direct Rollover vs. Indirect Rollover

A direct rollover refers to the process of transferring your retirement savings from your old employer’s retirement plan, such as a 401(k) or 403(b), directly into an IRA or a new employer’s retirement plan. The key feature of a direct rollover is that the funds are transferred electronically, meaning you never physically touch the money.

An indirect rollover, on the other hand, occurs when you physically take possession of the funds for a short period before depositing them into an IRA or a new employer’s retirement plan. In this case, the plan administrator will issue a check for your account balance, but 20% will be withheld for federal income tax. 

The potential consequences of these two types of rollovers are worth considering. Direct rollovers are generally preferred because they are not subject to mandatory withholding. This means you won’t lose any of your savings to federal taxes. But what about indirect rollovers? In the case of indirect rollovers, your plan administrator withholds 20% of federal income taxes. This means you’ll need to use other resources to deposit the full distribution into your new retirement plan or IRA within 60 days to avoid a potentially large tax bill.

Bottom Line

A senior couple meeting with a financial advisor to discuss the benefits and drawbacks of a 401(k) rollover.

A 401(k) rollover involves transferring your money into a new employer’s 401(k) plan or an IRA. The primary benefits of rolling into another 401(k) include potentially higher contribution limits and a wider range of investment options. However, there are drawbacks, such as possibly higher administrative fees and less flexibility in withdrawal rules. IRA rollovers, on the other hand, offer more investment choices and flexibility in terms of withdrawal options. The right option for you will depend on your needs.

Tips for Retirement Planning

  • A financial advisor can help you properly plan for retirement by helping you choose the right investments and make sure you’re ready for the long haul. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three 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.
  • You can use a free retirement calculator to help you estimate how much money you might need to save for the retirement you want.

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