There were several decisions to make when I changed career paths, including whether to pursue a 401(k) to IRA rollover.
After researching my options, I decided to roll over my 401(k). Now, I’ll walk you through the process to help you make the best decision for your situation.
What is a 401(k) rollover & how it works?
A 401(k) rollover is when you transfer your 401(k) plan from a previous employer to your new employer’s retirement plan or into an IRA (individual retirement account).
Similar company retirement plans, such as a 403(b) or 457(b), also qualify for a rollover IRA.
Your rollover options include:
- Traditional 401(k) to a traditional IRA
- Roth 401(k) to a Roth IRA
- Convert a traditional 401(k) into a Roth IRA
- Transfer your old 401(k) plan to a new 401(k)
Choosing to roll over a 401(k) to an IRA is more common than 401(k) transfers.
Several reasons include that company retirement plans are not universally available or are expensive. The investment options can also be less advantageous than a rollover IRA.
Either option lets you keep enjoying the long-term tax advantages of your traditional and Roth accounts. There are no penalties, taxes, or rollover fees in most situations.
Rolling over your 401(k) can help make your current nest egg more productive as you can procure better investment options.
You may also enjoy the benefit of fewer fees.
It’s also an opportune time to move your money to one of the best IRA accounts with your favorite investment options, research tools, and easy-to-use platform.
There are two leading reasons why I decided to transfer my 401(k) to an IRA.
First, my new employer didn’t offer a 401(k) plan so my existing account was “captive money” that I could rebalance but not add new contributions.
Second, I was paying annual administration fees and I could keep the same holdings in an IRA for free.
Plus, I now gained the ability to invest in numerous individual stocks, ETFs, and commission-free mutual funds more relevant to my investment strategy.
Specifically, my former employer’s 401(k) custodian was Vanguard. For simplicity, I opened a Vanguard rollover IRA for my traditional and Roth accounts as I was happy with my asset allocation, investment options, and pricing.
However, you can transfer to the IRA provider of your choice and even choose a self-directed IRA to hold physical assets like gold, precious metals, or crypto.
I also want to reiterate that you don’t have to pursue a rollover right after you quit.
Deciding if your new employer is a good career move takes time. It took me a year to figure out my employment situation so paying the annual administration fee was inconsequential.
How to Roll Over 401(k) to IRA
Most likely, you will perform a direct 401(k) rollover where your current plan administrator transfers your holdings to your new provider.
It’s consistently the easiest and quickest method to protect your tax-advantaged retirement contributions.
- Understand rollover options: Typically, traditional 401(k)s become a tax-deferred traditional IRA and tax-free Roth 401(k)s turn into a Roth IRA. Further, you can convert your traditional accounts into a Roth if you don’t mind paying income taxes upfront.
- Choose type of account: Most investors choose a brokerage IRA from an online stock broker to trade stocks and funds. Self-directed IRA custodians let you invest in alternative assets, such as a gold IRA or a crypto IRA with your retirement dollars.
- Ask questions about the process: Inquire about potential fees, tax implications, and if you can perform an in-kind transfer or must liquidate your positions for a cash transfer.
- Fill out required paperwork: You will fill out a form electronically or by mail with your new provider detailing your approximate account value. Anticipate corresponding with your old and new custodians to provide additional information as necessary.
- Begin the conversion process: A direct rollover to a new IRA custodian—sometimes known as trustee-to-trustee transfers—is the most common and usually takes up to one week. as you don’t touch the funds and usually take two to four weeks to complete.
- Start investing: You can select new investments from the available options and make new contributions up to your annual plan limit.
Your new account is designated as a rollover IRA instead of a traditional IRA or Roth IRA, yet you enjoy the same tax benefits plus more creditor protections.
The critical difference is that rollover IRAs can be transferred to participating workplace retirement plans.
Understanding Taxes & Penalties
You may encounter taxes and penalties in several situations outside of a standard direct rollover.
60-day rule
Indirect 401(k) rollovers only provide 60 days to cash out your existing plan and re-deposit your funds into your new custodian.
Any undeposited balance is subject to income taxes and a 10% early withdrawal penalty. This strategy is most common for individuals seeking a short-term loan without interest.
Your existing custodian may withhold at least 20% for taxes. If so, you must pull from personal savings until getting reimbursed when filing your tax return.
The IRS waives the 60-deposit window in select situations, such as financial institution errors.
Direct transfers normally finalize within 30 days or less, so this deposit deadline is a non-issue for nearly every rollover.
IRA one-rollover-per year
Current IRS rules only permit one tax-free rollover from an existing IRA per 12-month period when you make a distribution to prevent abuse.
An example is withdrawing from a traditional IRA and rolling the remainder into a Roth IRA. Once again, this rule doesn’t really impact 401(k) rollovers and direct IRA transfers since you’re not taking a distribution.
As a result, you can roll over your 401(k) as often as your plan guidelines allow and also switch IRA custodians if you desire.
Rule of 55
The “Rule of 55” allows employees to start making penalty-free withdrawals for traditional and Roth 401(k)s and 403(b)s the year they turn 55 or older.
Interestingly, public service workers qualify when they turn 50. Roth 401(k) withdrawals of earnings are still subject to income taxes if the account is open for five years or less.
The contribution portion remains tax-free so you avoid double taxation. You can start making penalty-free early withdrawals when you resign, retire, or get laid off from your employer the year you turn 55 or later.
If you’re nearing retirement, hanging onto your 401(k) might be better.
IRAs are still subject to the 59 ½ minimum withdrawal age and Roth IRAs must be open for at least five years to avoid taxable earning distributions.
Why should I convert my 401(k) to an IRA?
Here are several advantages of a 401(k) to IRA rollover:
- Not employer-linked: An IRA is independent from a particular employer, preventing future rollovers and the ability to save for retirement if you don’t have a workplace 401(k) available.
- Choose a different brokerage: You have a prime opportunity to choose a broker with your favorite research tools and potentially fewer fees. You may also move your assets to where you keep your current brokerage account for easy monitoring.
- Invest new money: Since your old 401(k) most likely won’t accept new contributions, a rollover can inspire you to boost your retirement savings.
- New investment options: Most IRAs have abundantly more investment choices than their 401(k) counterparts. You may decide to stick with stocks and funds, although a self-directed IRA opens the door to precious metals, cryptocurrency, and real estate.
- Minimize plan administration fees: Most brokerage IRAs don’t charge account service fees plus offer commission-free stock and ETF trades.
- Easy account monitoring: It can be easy to forget about accounts you no longer invest in. A rollover IRA helps prevent overlooking accounts in net worth tracking and estate planning.
Why shouldn’t I transfer my 401(k) to an IRA?
Rolling over your existing account isn’t always the best solution at the moment:
- Are at least 55 years old: The “Rule of 55” lets you make penalty-free 401(k) withdrawals when you retire early.
- Potential Roth IRA penalties: Withdrawing from a Roth retirement account within the first five years from account funding can result in paying taxes on earnings. This tax treatment applies even when you’re age-eligible.
- Loans and creditor protection: An active employer’s 401(k) can qualify for 401(k) loans. Further, 401(k)s and ERISA-protected employee retirement plans have more creditor protections than rollover IRAs. Laws differ by state.
- Delay required minimum distributions (RMDs): Active workers can delay RMDs from traditional 401(k)s and 403(b)s until they retire, but not with a traditional IRA.
Is it a good idea to rollover your 401(k) to IRA?
In most cases, converting your 401(k) to an IRA is ideal as you have significantly more investment flexibility.
Specifically, you can invest through one of the best gold IRAs to diversify your retirement portfolio and hold physical assets that can outperform stocks and bonds.
However, you may think twice if you’re near retirement or only want one retirement account to monitor and your new employer’s plan has excellent investment options and fees.
FAQs
Can I rollover my 401(k) to a Roth IRA?
Yes, Roth 401(k)s seamlessly roll into a Roth IRA penalty and tax-free. Traditional 401(k)s qualify for a Roth IRA conversion, although you pay income taxes on the balance.
Should I rollover my old 401(k) to my new employer?
A 401(k) transfer is suitable when your new employer has good investment options and low fees. You also maintain access to 401(k) loans and stronger creditor protections, but an IRA is better if you want to invest in stocks, ETFs, funds, precious metals, and cryptocurrency.
Can you roll a 401(k) into an IRA without penalties?
Most 401(k) rollovers are penalty-free as custodians perform a direct transfer or a trustee-to-trustee transfer where your only involvement is submitting the initial paperwork.
You receive a distribution check for indirect transfers that you must deposit within 60 days.
How much does it cost to roll a 401(k) into an IRA?
Your 401(k) administrator may charge transfer-out fees, but many IRA providers reimburse some or all of these fees through deposit promotions.
Self-directed IRAs may charge setup fees, but qualifying rollover balances may waive this and other first-year fees.