Should you roll over your 401(k)?

Quick Summary

  • A rollover is when you move the money you saved in your 401(k) at work to an IRA you control. Most rollovers happen when people retire or get new jobs.
  • Direct rollovers are relatively simple and don’t trigger any new taxes.
  • Doing a 401(k) rollover can help you save on fees and take advantage of better investment options.

401(k) Rollover Options

If you’re leaving a job and you’ve saved in a 401(k) or similar plan, you’ll want to figure out what to do with the money you’ve accumulated while at that job. In general, you have four options:

  1. Keep it in your original employer’s plan. This can be a good choice if you have an excellent 401(k) with good investment choices and low fees.
  2. Roll in over into your next employer’s 401(k). If you’re moving to a different company, check if its rules let you transfer your old balance to your new one. Only consider this option if the new plan is excellent.
  3. Roll in over into an IRA. With your own IRA, you have the most control. You can pick which company you want to work with and where you want to invest your money.
  4. Cash it out. Cashing out is usually a mistake. On a traditional 401(k) plan, you’ll owe taxes on all of your contributions plus tax penalties for early withdrawals if you’re under age 59 1/2.

When you’re making a decision, be sure to consider factors like tax implications, fees, investment options, and how easy it will be to manage your money. Here’s a closer look.

Tax Implications of Rollovers

The government gives people tax breaks on retirement savings. But different kinds of retirement accounts have different tax breaks.

401(k) to Traditional IRA Rollover

A direct rollover is the most common type of rollover. It’s done by your 401(k) plan administrator. You won’t owe taxes if you do a direct rollover from a regular 401(k) to a traditional IRA. You’ll pay taxes when you retire and start to draw money out. (Note that the rules are different for a Roth 401(k), as will be noted below.)

Some people chose to do an indirect rollover from a 401(k) to a traditional IRA. An indirect rollover is when you withdraw the money from your 401(k) and hold it for 60 days or less before depositing it into the same or another 401(k) or IRA. Usually, people do an indirect rollover if they need to borrow their retirement money. Indirect rollovers can trigger taxes or tax-reporting depending on how you do them.

401(k) to 401(k)

If you roll your 401(k) balance over to another 401(k) at a new job, you won’t pay taxes. You’ll pay them when you retire and start withdrawing the money.

401(k) to Roth IRA

You can do a rollover from a regular 401(k) to a Roth IRA, but it requires that you make a stop at a traditional IRA first. You do a 401(k) rollover first. Then you do a Roth IRA conversion.

You’ll pay taxes on the money when you convert to the Roth. That’s because you got a tax deduction for your contributions to your regular 401(k) and paid no taxes to move it to a traditional IRA, which is also designed to hold pre-tax money. A Roth, on the other hand, is a retirement savings plan for after-tax money. The benefit: When you withdraw the money from the Roth IRA when you retire, you won’t owe taxes.

Note that if your 401(k) is a Roth 401(k), you can roll it over directly into a Roth IRA without intermediate steps or tax implications. Both accounts contain after-tax money. You just have to check how to handle any employer matching contributions because those will be in a companion regular 401(k) account.

Traditional or Roth IRA

If you think your tax rate is higher now than it will be in retirement, it could be smart to roll over to a traditional IRA. If you think your tax rate is lower now than it will be in retirement, it could be a good idea to roll over to a Roth IRA. Whether taxes are higher or lower depends on how much you earn and whether the government has raised or lowered taxes. That is, of course, hard to predict.

IRA vs. 401(k) Fees

Fees can make a big difference in how much money you have when you retire. If you stick to low-cost investments in your IRA, you’ll probably pay less in an IRA than in a typical 401(k).

There are two important kinds of fees when it comes to rollovers. One kind is the fee that you are charged for your account. The other is the fee on the underlying investments—the mutual funds or ETFs—in your account.

Your 401(k) administrators should be able to give you a total cost for your retirement plan, in terms of the percent of your assets that you are paying. It will include the fee on the account and for the funds. Costs for typical 401(k)s can range from very low—under 0.5% a year—to quite high, as much as 2%.

Most banks and brokerages charge nothing or a nominal fee for an IRA or Roth IRA. If you stick to low-cost mutual funds and ETFs, those with fees of less than 0.5%, you will end up paying less than in a 401(k.) Broad-based index bond and stock funds often make good choices.

Investment Quality and Selection

Some 401(k)s have a good selection of investments. But IRAs often have a wider array of mutual funds, ETFs, and other investments, such as annuities. Make sure whichever option you pick has a selection of low-cost funds.

You might also wish to hire an investment advisor to help you decide which investments to hold in your retirement fund, whether it’s an IRA or 401(k). Be sure to include the cost of the advisor when you add up the fees you’re paying.

How Easy Is It to Manage Your Money?

Finally, you might find it easier to manage your money if it’s all in one account. That could mean doing a rollover each time you leave a job. You could roll over into your next job’s 401(k), if there is one. Or you could do a rollover into one IRA or one Roth IRA each time you switch.

Check your 401(k)’s rules on how easy it is to withdraw money or take out a loan. Some 401(k)s are more flexible than traditional IRAs when it comes to withdrawal rules. If you withdraw money from a traditional IRA before you are 59 ½, the withdrawal is taxable. Often, withdrawals are also taxed an extra 10%, with a handful of exceptions, including for some medical expenses and education.

Compare the IRA rules to your 401(k) rules to help you make a decision.

Roth IRAs offer the most flexibility of all. You can typically withdraw the total of your contributions (though not the income it earned) with no penalty.

Cashing Out Your 401(k)

There is one other rollover option: Cashing out your 401(k). But if you do that, you’ll be robbing your future self of the money you need to live on in retirement. And, if you’re under 59 ½,  you’ll likely get a whopping tax and penalty hit, as well. If you can avoid it, don’t cash out your 401(k).

How to Do a Rollover

A rollover from your 401(k) plan is easy. You pick a place, like a bank, brokerage or online investing platform, to open an IRA. Let your 401(k) plan administrator know where you have opened the account.

Then, you can do a direct rollover. This means that your plan administrator sends the money directly to the IRA you opened at a bank or brokerage. Or, he or she may cut you a check made out to your account, which you deposit. Going directly (no check) is the best approach.

You can also do a rollover from a distribution, also called an indirect rollover. In this case. your employer will give you a check made out to you. Taxes will be withheld, and you’ll have to report the distribution as income on your income tax return. You can avoid taxes if you do a rollover into another retirement account within 60 days and make up the money withheld from another source.

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