How to Roll Over Your 401(k)

April 22, 2022

How to Roll Over Your 401(k)

April 22, 2022

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Last Updated: April 9, 2024

Let’s start with what a 401(k) rollover is. When you transfer a balance from a previous existing 401(k), likely from a company you’re no longer employed by or in the process of leaving, to a new or existing 401(k) with your current (new) employer or into an IRA, this is considered a 401(k) rollover.

You have several options for your 401(k) when leaving a job, including rolling the account over into an IRA or your new employer’s 401(k) plan, that can save—or cost—you tens of thousands of dollars. Where you roll your account can have tax implications and different fees and investment options than your current 401(k) plan.

If you like your investment options and fee schedule for your current 401(k), it may be advisable to leave it in your previous employer’s plan. On the flip side, if your new employer offers a more attractive 401(k), you may wish to roll it over to the new plan.  If your new employer does not offer a retirement plan or you’re not actively working, an option you can pursue is rolling over your 401(k) into an IRA, which offers more investment options. For a more in-depth breakdown of options for your 401(k) when leaving a job, see 4 Options for your 401(k) When You Leave a Job.

One key to rollovers is understanding direct vs. indirect rollovers. A direct rollover is when your former plan administrator makes the fund payment directly to your new plan administrator to transfer funds to your new 401(k) or IRA. No taxes are withheld in this type of transfer. An indirect rollover means you’re the middleman for the transfer—your former plan administrator cuts a check to you, which you deposit into your bank account, then transfer into your new account. Twenty percent is required to be withheld for taxes, meaning the final check with be short 20%; however, you’re required to deposit the amount in full (including the 20% withheld) within 60 days of initiating the rollover to avoid paying penalties. This means you’ll need to come up with the additional withheld amount from other sources, like your checking or savings account or other investments. You will get the 20% withheld back at tax time, assuming you met the IRS deadlines. In general, this type of rollover is highly inadvisable unless absolutely necessary.

Your two options for rolling over a 401(k) are to your new employer’s plan or an IRA. To help decide, ask yourself (via Bankrate):

  • Do you want to invest the money yourself or would you rather have someone do it for you? An IRA may be a good option if you’re a do-it-yourselfer. Robo-advisors may offer lower fees in combination with a level of assistance above doing it yourself, as they can help you build an appropriate personalized portfolio. Rolling your 401(k) into your new employer’s 401(k) can make more sense if you want a done-for-you option.
  • Does your old 401(k) have low-cost investment options with potentially attractive returns, and does your current 401(k) offer similar or better options? Before rolling your 401(k) into your current employer’s plan, you’ll want to assess the investment options, fees, and other relevant aspects to ensure it’s the best fit for you and offers what you need to meet your financial goals—and a better option than your old plan. If it’s not, then an IRA rollover could be a better bet for you, since you’ll have a wider range of investment options, really anything that trades in the market. IRAs tend to have lower fees, too, depending on your custodian and investments. If your new employer’s 401(k) is less attractive, it might make more sense to keep your old 401(k) where it is.
  • Does your current 401(k) plan offer access to financial planners or other support to help you invest? The level of investment and planning support you need or want may dictate where you move your 401(k). If your new plan offers you access to financial planners or investment professionals, rolling your account over may make sense. Moving your money to an IRA means you’ll have to manage it yourself and pick investments or hire someone to do it.

Keep in mind that a 401(k) rollover isn’t right for everybody, whether it’s to another 401(k) or an IRA. If your previous employer’s plan has better fees, investment choices, and other options, it may be best to leave it there. Also, a 401(k) is generally better protected from creditors than an IRA, depending on state laws. Lastly, most 401(k)s allow you to take out a loan, but IRAs do not offer this benefit. If this is something you may need for a future short-term need or emergency, rolling your account over into an IRA may not be ideal.

Once you’ve decided what kind of account you want to roll your 401(k) into, you need to open the new account and/or initiate the transfer. Consolidating your accounts into one can be incredibly helpful for managing your investments, tracking performance, and preparing for retirement. For the purposes of the rest of this article, we’ll discuss two processes: 1) rolling your account into your current/new employer’s 401(k) plan, and 2) opening a new IRA and/or rolling the money into an existing IRA.

If you’re rolling your existing 401(k) into your current/new employer’s plan:

  1. You’ll need to open your new 401(k) account with the plan administrator before you can initiate a rollover. Some companies may delay your option of opening a 401(k) until you’ve been with the company for a certain amount of time. Check your 401(k) plan information or with your benefits administrator for specifics.
  2. You’ll need to complete all the required forms to move the money from your former to current employer’s plan.
  3. Initiate a direct rollover by having your former plan administrator cut a check or electronically transfer the funds directly to your new plan administrator. Avoid indirect rollovers, where your former plan administrator sends a check to you to deposit into your new plan unless absolutely necessary—this has a required tax withholding and specific deadlines you must meet when depositing the funds.
  4. Close your old account.
  5. Choose your investment/fund options in your new account—either with the help of a robo-advisor, financial professional, or yourself.

If you’re rolling your existing 401(k) into a new IRA:

  1. You’ll need to use a bank or brokerage firm to open an IRA. Depending on if you want to use a robo-advisor, play a more active role in managing your investments, or have someone else do it for you completely, seek out the best bank or brokerage option for you. There are minimum balance requirements, investment offerings/options, service options, and other factors you’ll want to research and compare before selecting one.
  2. Choose which type of IRA you want to start:
    1. A Roth IRA will roll the untaxed funds into a tax-free investment account, meaning your funds will grow tax-free and you can make withdrawals in retirement without paying taxes on the distributions, as long as the account has been open for five years or more. However, this creates a taxable event upon opening and funding the account, so you’ll pay taxes on the amount you’re rolling over. If you’re in a high tax bracket already and will need the funds in less than five years, a Roth IRA may not be the best choice, as you may not fully capitalize on the tax-free growth before you start drawing down on the account and you’ll have a high upfront tax bill.
    2. A traditional/rollover IRA will roll the untaxed funds into a tax-deferred account, much like a 401(k). You’ll pay taxes on withdrawals in retirement, but nothing when you perform the rollover.
    3. If you’re rolling a Roth 401(k) to a Roth IRA, you won’t incur taxes because these are funded with post-tax dollars.
    4. Consult with a tax professional if possible to avoid any unanticipated tax consequences and for retirement tax planning.
  3. Once you’ve opened your IRA, you’ll follow the process outlined by the administrator. You’ll have paperwork to fill out and certain requirements you may have to follow to avoid complications.
  4. Again, initiate a direct rollover for the funds into your IRA.
  5. Close your old account.
  6. Choose your investment/fund options—either with the help of a robo-advisor, financial professional, or yourself.

There are no limits to how much you can roll over into an IRA, and your rollover does not count as a contribution. You can continue to contribute funds to your IRA according to the IRS contribution limits and income limits, if applicable. If you have an existing IRA, you may be able to roll your 401(k) into that vs. opening a new IRA. Check with your bank or brokerage firm to determine if you can do this. You may also be able to split your rollover into a traditional and Roth IRA and/or leave some of your assets in your former employer’s plan.

One big exception to everything we’ve discussed so far is if you hold your ex-company’s stock in your 401(k). Because of net unrealized appreciation (NUA), which is the difference between the stock’s value when you purchased it and its value upon distribution, you may want to keep this portion in your previous 401(k) account. Any increase in NUA is considered a capital gain, and if you take a distribution on this stock, you’ll pay capital gains taxes.

According to Investopedia, “You’re only taxed on the NUA when you take a distribution of the stock and opt not to defer the NUA. By paying tax on the NUA now, it becomes your tax basis in the stock, so when you sell it (immediately or in the future), your taxable gain is the increase over this amount. The usual more-than-one-year holding period requirement for capital gain treatment does not apply if you don’t defer tax on the NUA when the stock is distributed to you. In contrast, if you roll over the stock to a traditional IRA, you won’t pay tax on the NUA now, but all of the stock’s value to date, plus appreciation, will be treated as ordinary income when distributions are taken.”

Overall, your decision to leave or roll over your 401(k) involves many factors, including current and future tax implications, plan fees, and investment options. Consolidating your 401(k) into one account can be a great idea, especially as you progress through your career and likely have had multiple 401(k)s through different employers. No matter what you decide to do, take an active role in your retirement planning and keep track of your account(s) performance to drive your decisions. Consult a financial and tax professional for more information specific to your situation.

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References

Department of Labor. (September 2019). A Look at 401(k) Plan Fees. https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/a-look-at-401k-plan-fees.pdf

FINRA. (n.d.) 401(k) Rollovers. https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-rollovers

Internal Revenue Service. (August 16, 2021). Rollovers of Retirement Plan and IRA Distributions. https://www.irs.gov/retirement-plans/plan-participant-employee/rollovers-of-retirement-plan-and-ira-distributions

Investopedia. (December 1, 2021). Your Guide to 401(k) and IRA Rollovers. https://www.investopedia.com/articles/personal-finance/092214/guide-401k-and-ira-rollovers.asp

Levy, Adam. (October 21, 2021). How to Rollover an Old 401(k). The Motley Fool. https://www.fool.com/retirement/plans/401k/rollover/

Marquit, Miranda. (December 1, 2021). Guide to 401(k) Rollovers. Forbes. https://www.forbes.com/advisor/retirement/what-is-401k-rollover/

O’Shea, Arielle, & Orem, Tina. (February 8, 2022). 401(k) Rollover to IRA: How to Do It in 4 Steps. Nerdwallet. https://www.nerdwallet.com/article/investing/401k-rollover-ira-guide

Royal, James, & Goldberg, Matthew. (June 9, 2021). How to roll over your 401(k) in 5 easy steps. Bankrate. https://www.bankrate.com/retirement/401k-rollover-guide/

Zinn, Dori. (November 29, 2021). Not Rolling Over Your 401(k) From a Former Employer Could Cost You. Here’s Why. Time. https://time.com/nextadvisor/investing/how-to-roll-over-401k/

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