Here’s How to Roll Over a 401(K) Into an IRA

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One of the most common perks of working for an employer is the company-sponsored 401(k) plan. But what happens to that money when you leave your job? 

If you’ve job-hopped a lot, chances are you already have a few 401(k)s floating around.

When you leave a company, you’ll have several options for what to do with your 401(k) plan. Because most 401(k) plans are set up for employees to contribute pre-tax dollars and then refrain from withdrawing any money until they are at least 59 ½ years old, you should try to avoid early withdrawal fees, whatever you do. 

Here’s how to roll over a 401(k) to an IRA and how to decide which option is right for you. 

Keeping Your Current 401(k) Plan

First off: Whatever you do, don’t take the cash out. This means cashing out your 401(k) and depositing that amount into your checking account and using it toward other expenses. This is a bad idea. If you do, you’ll get hit with a penalty from the IRS, and the money will count as income that increases your federal taxes for the year. Although it may be tempting, try other options instead. 

One of the easiest things you can do instead is simply leave your current 401(k) balance where it is, even though you won’t be able to make any additional contributions. 

This option might be right for someone who is happy with the fees and performance of their current 401(k) plan and who doesn’t have another retirement account to move the balance to.

But this option may not be the best because in a decade or two, you may have a handful of 401(k) plans sitting with previous employers, making them easy to lose track of and difficult to manage. 

Also, not every employer allows you to keep your 401(k) open after you leave. Some might have a minimum balance requirement or require that you rehome your retirement funds into a new account with the same investment manager. 

It could also depend on the size of your employer. Larger companies “don’t mind having extra participants in their plan,” says Mark Deering, a CFP and Senior Executive Vice President at Southwestern Investment Group. “Smaller plans will often try and force out participants once they leave service to avoid having their plan audited or face higher administration costs.”

Rolling Over Your 401(k) to an IRA

Another option when you leave a job is to roll your 401(k) balance into an IRA — or individual retirement account. An IRA is also a tax-advantaged retirement account, but rather than being sponsored by an employer, it’s self-directed.

One of the primary reasons someone might choose to roll their 401(k) into an IRA is the wider variety of investments available, says Lazetta Rainey Braxton, a certified financial planner and the co-founder of the financial planning firm 2050 Wealth Partners

“With the rollover IRA, you have more options in terms of what you can invest in, whereas with an employer 401(k), it’s the employer’s responsibility to figure out what the investment menu is,” Braxton says.

If you already have an IRA, then you can often roll your 401(k) balance into your existing account. If you don’t already have an IRA, then you’ll have to open one before you can initiate the transfer.

Once you have an IRA, contact your former 401(k) plan administrator and let them know you’d like to roll the balance over. They may require paperwork completed by either you or your IRA provider.

The rollover will happen in one of two ways:

  1. The 401(k) administrator may be able to send the money directly to the IRA provider, who will then deposit it into your account. 
  2. Or, you may receive a check with your 401(k) balance, which you’ll then have to deposit into your IRA. You must do so within 60 days or the check will be considered a withdrawal, which would trigger an early withdrawal penalty and income taxes. A lot of brokerages have user-friendly interfaces that allow this process to be done digitally by simply taking a picture of the check and depositing it into the account.

Rolling Over Your 401(k) to a Traditional IRA vs. a Roth IRA

You have the option of rolling your 401(k) into either a traditional IRA or a Roth IRA. One isn’t better than the other, and ultimately it’s up to you and your investment goals.  

You do have to worry about a few things, though, and the major difference is this: Roth IRAs require after-tax contributions. If you’re rolling over money from a traditional 401(k), then you haven’t paid taxes on that money as it came out of your salary before you got your paycheck. As a result, rolling your traditional 401(k) balance over to a Roth IRA will require you to pay income taxes on the entire balance in the year that you do the rollover. This could mean thousands of dollars in taxes. So just be cautious of this.

However, rolling a traditional 401(k) into a traditional IRA is easier, since both contain pre-tax dollars. You don’t have to worry about triggering a taxable event. 

On the same note, a Roth 401(k) and Roth IRA are both funded with after-tax dollars, meaning rolling one into the other wouldn’t require a tax payment.

Paying income taxes by rolling a traditional 401(k) into a Roth IRA isn’t necessarily a reason not to do it: Roth IRAs can be a powerful retirement savings tool, and some investors may prefer to pay the tax bill now for the benefit of withdrawing the money tax-free during retirement. 

But whatever decision you make, it’s important that you understand the consequences and have your budget ready.

Rolling Over to a New 401(k)

If you’re moving to a different employer that also offers a 401(k), then you might consider rolling your balance over to the new company. The benefit of this option is the simplicity — you’ll have just one retirement account to keep track of, rather than multiple accounts.

In most cases, this type of rollover can be as easy as filling out a few online forms, and the companies that manage your 401(k)s can usually take care of things on their end.

“This process is most frequently initiated by paperwork from the receiving 401(k) plan,” Deering says. “For example, if my 401(k) was at T. Rowe Price and I wanted to roll over an older 401(k) plan I had at Fidelity, I would contact T. Rowe Price to get their rollover paperwork and submit it to Fidelity to make the check distribution.”

Cashing Out Your 401(k)

When you leave a job, it can be tempting to cash out the 401(k), but this should only be done in extreme circumstances. Not only will you rob your future self of your retirement savings, but you’ll lose a significant amount of the value.

When you cash out your 401(k), you have to pay income taxes on it, as well as an additional 10% early withdrawal penalty. You could easily lose 30% of the account balance to taxes and fees.

Additionally, cashing out your 401(k) now reduces the amount of money you’ll have available to you during retirement. As long as that money isn’t in the market, it’s not growing.

Beware of convincing yourself that you’ll be able to replace it later. Because of compound interest, time makes all the difference. The more time your money is invested, the more opportunity it has to grow into a comfortable retirement nest egg.

“This is rarely ever the best thing to do,” Deering says. “It takes a lot of effort, time, and resources to save for retirement, and every dollar helps.”

How to Decide Which Rollover Is Right for You

When you leave an employer, you’ll have to decide if you want to leave your 401(k) in place, roll it over into an IRA, or roll it over into a new 401(k). 

First, consider the fees that each plan charges. If you find that the fees at your previous company are higher than what you’d pay at your new company or in an IRA, then it makes sense to roll your balance over. Moving the money to an IRA can be an effective way to save on fees — some online brokerages offer 0% expense ratios on index funds.

Pro Tip

When deciding what to do with your 401(k) balance when you leave a job, consider factors like your investment performance up until this point, the fees your plan charges, and the variety of investment options available to you. Compare those factors with your new employer’s 401(k) or an IRA to decide which plan is more appealing.

Also, consider the investment options available to you. 401(k) plans usually come with a select list of investments you can choose from, while an IRA has far more options. Some investors may prefer to have more options, while others may find it overwhelming.

“You have to be comfortable making those selections or working with a financial planner or advisor who can provide guidance for you as well,” says Braxton.

That being said, investors who want to roll their 401(k) over into an IRA and aren’t comfortable choosing their own investments may also consider a robo-advisor, which chooses investments on your behalf based on your time horizon and financial goals. Robo-advisors are great ways for all investors to take charge of their investing. 

What to Do With Employee Stock

If you have employee stock through your former employer, you’ll also have to decide what to do with those shares. In the case of stock you already own, Deering advises that it might make sense to sell those shares. At the very least, ensure the stock doesn’t make up a disproportionate percentage of your portfolio, as can sometimes happen with employee stock.

According to Deering, the primary consideration is whether there’s anything that prevents you from selling the stock. In some cases, there may be lock-up periods that bar you from selling your shares for a particular amount of time. And if you’ve owned the shares for less than one year, then it makes sense to hold them until the one-year mark when you qualify for long-term capital gains tax treatment.

If you have any remaining stock options, those will likely expire within three months of leaving the company. Whether you choose to exercise those should depend on the current stock price compared to the price your options allow you to purchase them at, as well as how much of the company’s stock you already have in your portfolio.