If you’re close to retirement or changing jobs, you may need to figure out what to do with the savings in your 401(k) account. This is where a 401(k) rollover comes in handy.
What is a 401(k) rollover?
A 401(k) rollover is when you move money from a 401(k) into another tax-advantaged retirement account. You have 60 days from the date you receive the cash or assets from your 401(k) to put it into another retirement plan.
There are four main options you can choose from when trying to figure out the best thing to do with your old 401(k):
Roll your old 401(k) into a new employer’s 401(k) plan.
Keep your old 401(k) with your former employer.
Each option has different tax implications, so it’s important you understand them before making a decision.
401(k) rollover to IRA
Rolling over your 401(k) to an IRA has its benefits, including more investment choices, and sometimes lower fees.
There are three types of 401(k) rollovers you can do if you decide you’d like to roll your assets into an IRA:
A rollover from a traditional 401(k) to a Roth IRA – you’ll owe taxes on the rolled-over amount.
A rollover from a traditional 401(k) to a traditional IRA – the taxes are deferred.
A rollover from a Roth 401(k), to a Roth IRA – you won’t incur taxes.
How to roll a 401(k) into an IRA
Here’s how to start and finish a 401(k) to IRA rollover in three steps.
1. Choose which type of IRA account to open
An IRA may offer you more investment options and lower fees than your old 401(k) had.
2. Open your new IRA account
You generally have two options for where to get an IRA: a robo-advisor or an online broker.
If you’re not interested in picking individual investments, a robo-advisor might be a good option. Robo-advisors build personalized portfolios using low-cost funds based on your preferences, then rebalance those funds over time to help you stay on track, usually for a much lower fee than a conventional investment manager.
If you want to build and manage your own investment portfolio, an online broker lets you buy and sell investments yourself. Look for a provider that charges no account fees, offers a wide selection of low-cost investments, and has a reputation for good customer service.
3. Ask your 401(k) plan for a direct rollover
Here are the basic instructions for a direct rollover:
Contact your former employer’s plan administrator, ask for a direct rollover, complete a few forms, and ask for a check or wire of your account balance to be sent to your new account provider.
The new account provider gives you instructions for how the check or wire should be made out, what information to include, and where it should be sent.
Indirect rollovers – remember the 60-day rule
If you would prefer not to do a direct rollover, you can opt for an indirect 401(k) rollover instead. This essentially means you withdraw the money and give it to the IRA provider yourself, but that can create tax complexities. A direct rollover might be easier.
Why? If you do an indirect rollover, the plan administrator may withhold 20% from your check to pay taxes on your distribution. To get that money back, you must deposit into your IRA the complete account balance — including whatever was withheld for taxes — within 60 days of the date you received the distribution. (The exception to this is if you want to open a Roth IRA, which will require taxes paid on the distribution, unless your money was in a Roth 401(k).
For example, say your total 401(k) account balance was $20,000 and your former employer sends you a check for $16,000 (that’s the full account minus 20%). Assuming you’re not planning to go the Roth route, you’d need to come up with $4,000 so that you can deposit the full $20,000 into your IRA.
At tax time, the IRS will see you rolled over the entire retirement account and will refund you the amount that was withheld in taxes.
Investing the money in your IRA
Once the money is rolled over into your new IRA account, select your investments.
Index funds: You can put index funds in your IRA, which is a fund that aims to mirror the performance of a market index such as the S&P 500.
ETFs: These investments often make sense for many people because they’re a basket of assets, such as stocks or bonds, that can be bought and sold during market trading hours. ETFs are a good way to diversify a portfolio.
Stocks: Individual stocks are also an investment option for IRA accounts.
Mutual funds: These are investments that combine money from investors to buy stocks, bonds, and other assets. Mutual funds are another way to create diversification in your portfolio.
Real estate: You can hold real estate in your IRA, but you’ll need to do so by means of a self-directed IRA.
Cryptocurrency: Bitcoin, Litecoin and Ethereum are all examples of alternative investments you can choose.
Target-date funds: 401(k)s often allocate money into target-date funds, which buy shares of other mutual funds with the goal of shifting investments automatically over time as you approach a specific date, such as retirement. If you like that approach, you probably can find a similar (and perhaps less expensive) target-date fund for your IRA at an online broker.
Those who would rather automate the investing process can use a robo-advisor for this. When you open a new account at a robo-advisor, that robo-advisor’s algorithms usually will select your investments based on questions you answer.
Rolling your old 401(k) over to a new employer
To keep your money in one place, you may want to transfer assets from your old 401(k) to your new employer’s 401(k) plan. Doing this will make it easier to see how your assets are performing and make it easier to communicate with your employer about your retirement account.
To roll over from one 401(k) to another, contact the plan administrator at your old job and ask them if they can do a direct rollover. These two words — “direct rollover” — are important: They mean the 401(k) plan cuts a check directly to your new 401(k) account, not to you personally.
Generally, there aren’t any tax penalties associated with a 401(k) rollover, as long as the money goes straight from the old account to the new account.
Although this route may help you stay organized with fewer accounts to keep track of, make sure your new 401(k) has investment options that are right for you and that you aren’t incurring higher account fees.
Keeping your 401(k) with a former employer
If your ex-employer allows it, you can leave your 401(k) money where it is. Reasons to do this include good investment options and reasonable fees with your former employer’s plan. Keep in mind that you may not be able to ask the plan administrator any questions, you may pay higher 401(k) fees as an ex-employee, and you can’t make additional contributions.
Another noteworthy thing to consider is that your former employer could decide to move your old 401(k) account to another provider. If your balance is between $1,000 and $5,000 and your former employer wants to close your old 401(k) account, your former employer can, but it is required to transfer the balance to an IRA in your name and notify you in writing. For balances under $1,000, your former employer can send you a check, which you’d need to put in a retirement account within 60 days to avoid taxes and penalties.
Cashing out your 401(k)
The last option you have for an old 401(k) account is cashing it out, but that may come at a high cost. You can ask your former employer for a check, but as with the indirect rollover, your former employer may withhold 20% to pay Uncle Sam for your distribution. The IRS also may classify this cash out as an early distribution, meaning you incur a 10% penalty and potentially taxes unless it’s a qualified distribution.
no account fees to open a Fidelity retail IRA
Is a rollover IRA the same as a 401(k)?
Is there a limit on the amount of money I can roll over to an IRA?
Does my rollover count as a contribution?
After I create a rollover IRA, can I contribute money to it?
Can I have more than one rollover IRA?
Downsides of doing a 401(k) rollover