How to Rollover Your 401(k)

Point of Interest

Once you change or leave a job, your 401(k) account can go with you to a new home

Employers offer retirement plans known as 401(k)s to employees to assist with saving for retirement. When you leave a job, you’ll have to decide what you want to do with the retirement savings you’ve accumulated. For many former employees, the best option is a 401(k) rollover to IRA.

What is a 401(k)?

401(k) accounts are retirement savings accounts sponsored by employers to benefit their employees. These types of accounts allow employees to invest for future retirement in a tax-advantaged account. Often, employers will offer incentives and matching bonuses to help employees save even more money towards retirement. 401(k) retirement accounts consist of a combination of stocks, bonds and mutual funds.

What does it mean to rollover a 401(k)?

When you leave your job where you’ve built up a 401(k) account, you’ll have a few options for what to do with those funds. Your first option is to cash out your account. The problem with this option is that you’ll most likely incur a prepayment penalty.

Some employers will allow you to keep your 401(k) with the company even after you leave. While this might be a suitable option for some, it creates issues tracking multiple accounts in the future. Additionally, many employers do not offer it as an option.

A third option is rolling over your 401(k). The term rolling over your 401(k) refers to converting your current 401(k) into either a new 401(k) with a new employer or into a non-employee-sponsored retirement account. When you roll over into a new 401(k) account, everything continues as normal except with a new company that oversees retirement accounts for your new company.

If you rollover your 401(k) to a non-employee-sponsored retirement account, you’ll be converting it into an Individual Retirement Account (IRA). IRAs are similar to 401(k)s, except they are not handled through an employee and don’t come with any sort of matching benefit (if previously offered by your employer). Additionally, they provide other means of investing not available through 401(k)s.

How to rollover a 401(k)

1. Decide on the type of IRA you want.

IRA accounts come in two different forms: Roth and traditional, just like 401(k)s. Before you can roll your account into one of these, you need to decide which you would like to use. The benefits and drawbacks of each are the same as with your 401(k). Many investors elect to stay with the same type of IRA as the type of 401(k) they are coming from.

2. Choose between a direct or indirect rollover.

There are two ways that your retirement funds will get from your existing retirement plan into your new account — direct and indirect rollovers. While the outcome of each is the same (if you follow all of the steps), there is still a decision to be made. Direct rollovers are when your current retirement funds are directly deposited into your new retirement account. In this situation, you never take ownership of the funds. This protects you from any penalties or income tax.

With an indirect rollover, the retirement funds are sent directly to you. You’ll have 60 days to deposit them into your new retirement account to avoid taxes or penalties. Again, while the outcome is the same, this can create issues if you don’t precisely follow every step of the rollover process. Hold the funds for longer than 60 days, and you lose the penalty and tax protections.

3. Determine any changes to your investment portfolio.

IRA accounts offer a more comprehensive array of investment products for you to choose from. Typically, 401(k) accounts are somewhat limited to what is offered by the company the employer has contracted through. While you don’t need to make any changes, you may want to see if there are any new or different investments previously not available that are a better fit for your financial goals.

When rolling over a 401(k) makes sense for you

There are many reasons rolling over a 401(k) is the best decision when you change or leave a job. Cashing out your account can be costly if you’re not at the age of retirement. You’ll pay taxes as well as prepayment penalties of 10%. By rolling your account over, you continue to enjoy the tax advantages of retirement accounts.

Moving to an IRA will also give you additional investment options. Instead of just stocks, bonds, and funds, you can now invest in things like CDs and real estate.

Realistically, there are no real downsides to rolling over your 401(k). The process allows you to continue saving for retirement without incurring any penalties or drawbacks just because you changed employers or left your job. The decision to roll over or not to roll over will depend on your particular financial situation.

Types of IRA providers

With 401(k)s, you don’t have to worry about choosing a provider; your employer does that for you. When you are on your own, though, you’ll need to decide on the best type of IRA provider for you.

The first significant decision you have is managed versus self-managed. Managed IRA plans have professional advisors who make the investment decisions for you — it’s a hands-off approach. Self-managed IRAs allow you to make all the investment decisions by yourself. While this can save you money on fees and expenses, it does require knowledge to know what you’re doing.

An “in the middle” option is a robo-advisor IRA account. These types of retirement accounts use computers and artificial intelligence to make statistically driven decisions for your portfolio. It might seem strange letting a computer invest for you. However, robo-advisors leverage technology and extensive data sets to make the best decisions they possibly can. 

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