401K IRA Rollover Rules
- A 401k IRA Rollover is when you move money you saved in a 401k at work to an IRA at a bank or brokerage.
- Most people do a 401k rollover to a Traditional IRA when they change jobs or retire.
- There are rules about how to do rollovers. If you break the rules, you might have to pay more in taxes or face penalties.
When you leave your employer, either because you get a new job or retire, you might wonder what to do with the money you saved for retirement in your 401k. We’ll review all of the details:
- Rollover Options
- Rules On Kinds Of Rollovers
- How To Do A Rollover
- Contribution Limits
- The Most Important Rule
You have four main options with your 401(k) when you leave an employer for a new job:
Cash it out. Cashing it out is usually a mistake. On a traditional 401k plan, you'll have to pay taxes on all of your contributions plus tax penalties for early withdrawals. This means you’ll lose all the benefits you worked so hard to accrue. Keep it in the original employer's plan. Especially if you have an excellent 401k with good investment choices and low fees, this could be a good option. Otherwise, you should consider rolling over. You can learn more here. Roll it over into your next employer's 401k. Frequently, you can transfer an old balance to a new plan. Only consider this is your new plan is excellent. Roll it over into an IRA. With your own IRA, you have the most control. You can pick what company you want to work with and where you want to invest your money. For most investors, doing a rollover into an IRA they control makes sense, especially if you stick to low-cost index funds. Fees on most IRAs are lower than 401ks. For help deciding whether to do a rollover, see What Is A 401k To IRA Rollover? Should I Rollover?
There are different kinds of retirement accounts. If you are wondering whether a rollover is allowed or whether you will have to pay taxes, remember that doing a rollover between accounts that are taxed in similar ways usually doesn't trigger taxes.
Most rollovers are of traditional, tax-deferred 401ks or other employer plans like a 403(b) to Traditional IRAs. You don't owe taxes on money saved in 401ks or Traditional IRAs until you retire and start withdrawing the money.
You can also do a rollover from a Roth 401k to a Roth IRA. That doesn't trigger taxes, either.
To do a rollover from a 401k to a Roth IRA, however, is a two-step process. First, you rollover to an IRA and then you convert to a Roth IRA. That's called a conversion, and has separate rules.
There are other kinds of retirement accounts, too, such as SEP or SIMPLE IRAs You can see a summary of what kinds of rollovers are allowed in this IRS chart.
A rollover from your 401k plan is easy. You pick a place, like a bank, brokerage or online financial advisor, to open an IRA. Let your 401k plan administrator know where you have opened the account.
Then, you can do a direct rollover, which means that your plan administrator sends the money directly to the IRA you opened at a bank or brokerage. He or she may also cut you a check made out to your account, which you deposit.
You can do a rollover from a distribution, also called an indirect rollover. Your employer may give you a check made out to you. Taxes will be withheld, and you will have to report the distribution as income on your income tax return. But you can still avoid taxes, if you do a rollover of the money into another retirement account within 60 days and make up the money withheld from another source.
Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.
For more on how to report an indirect rollover on your taxes, check this IRS site.
Once you have established a rollover IRA, you can make contributions to it up to the annual limit. For 2016-17, the contribution limit is $5,500, or $6,500 if you are over 50. If you are doing a different kind of rollover into a different kind of IRA or retirement plan, you can check out contribution limits here.
The most important rule is: Don't Cash Out. Unless you are in a real crisis or you meet the criteria for emergency withdrawals, you should keep your money in a tax-deferred account. That can be a 401k or an IRA. If you cash out for good, you will pay taxes and penalties. You'll be robbing your future self of the money you need to live on as an elderly person.