New job? New 401(k).
After my first few jobs, I felt like I was collecting 401(k) accounts.
I had no idea where the accounts were, how much was in them, or how I had invested the money.
Most folks I know tend to switch jobs every 2-3 years. After a full career, that’s 20 different 401(k) accounts.
No wonder people give up trying to track this stuff.
Luckily, there’s a way to simplify all this. By rolling your old 401(k)s into a new account, you can keep your money, avoid taxes, and get rid of the old account entirely.
It’s a good habit to do whenever you leave a job. That gives you one account to manage instead of 20.
You’ve got two options on how to handle this:
- Roll your old 401(k) into a new 401(k) if you’ve got one
- Roll you old 401(k) into your personal IRA account
In this article, we’re going to do a deep dive into how to roll your old 401(k) into your personal IRA.
What is a Rollover?
After leaving a job, you have multiple options to move the money in your 401(k) account to another type of protected retirement account, called rolling over the account.
You don’t have to roll the money into a new retirement account, but it is the smartest choice when you want to continue saving for the future without suffering multiple penalties.
The majority of people will choose to roll over the 401(k) funds into an IRA, or individual retirement account. From a tax benefit standpoint, the IRA works in a similar manner to the 401(k), minus the contribution from your employer, of course. And since it’s a personal IRA, you have full control of the account and investments.
7 Reasons For Rolling Over Your 401(k) to an IRA
Moving your 401(k) account funds into an IRA is easy and efficient. Here are the seven best reasons to move your retirement funds from your old employer’s 401(k) to an IRA.
- Ease of management. Having a majority of your retirement money in one IRA makes it easier to manage versus having the funds scattered in accounts at multiple brokerages.
- Ease of use. The IRA has a lot of the same tax deferral benefits of the 401(k), so you don’t have to learn a lot of new jargon or rules when rolling over the 401(k) into an IRA.
- IRAs have a lot of investment options. As a general rule, an IRA will give you more options for investing your money than a 401(k) account. Many 401(k)s have an extremely limited fund section, usually 20 options at most. With your IRA, you can pick any fund you want.
- Lower fees. In a 401(k), you will pay whatever fees the plan assesses to your account. You don’t have a choice. But with an IRA, you can pick a brokerage that has a fee structure with which you are comfortable.
- You may receive a bonus. Some brokerages give you bonus money for opening a new IRA. And we all like free money.
- You can contribute more. With the newly opened IRA, you have the ability to contribute to it throughout the year, increasing your retirement balances up to the limit the IRS sets. So if you have both a 401(k) at your new employer and an IRA, you can contribute to both accounts.
- You have the final choice. In a 401(k), you don’t have a say in the plan administrator, the investments offered, or the brokerage being used. You just have to go with whatever the employer offers. With an IRA, you can pick whatever brokerage you want.
How to Roll Over Your 401(k) to an IRA
Follow these steps when doing a 401(k) rollover to an IRA.
1. Open your IRA
Any brokerage or bank should have an IRA option you can use. In general, stick with an investment bank that you’re already using.
If this is your first personal investment account, Vanguard, Charles Scwab, Fidelity, and TD Ameritrade are all good options.
Go to their site and find the option for opening an IRA. It typically takes 15-20 minutes.
2. Transfer your funds
After opening the IRA, you should receive instructions for rolling over your 401(k) balance into the IRA. If not, they usually have a guide in the support section of their site.
You may need to contact the 401(k) plan administrator at your old employer, or the institution that contains your IRA may be able to take this step for you. Some 401(k) plans will hand you a distribution check that you must deposit yourself into the IRA, while some will allow an electronic transfer to the IRA.
If at all possible, have them transfer the money for you. If the money isn’t transferred in time, you could be forced to pay taxes on it. Have the banks worry about this stuff.
3. Pick your investments
When the money hits your new IRA account, it’ll likely stay in cash. It won’t be invested automatically.
Remember to log into your new IRA and invest that cash. Over time, cash loses its value to inflation. You also miss out on the investment gains that you could have had.
I use rollovers as a chance to rebalance my portfolio. If my asset allocation is out of alignment, I’ll make new investments to get back on target. The lazy portfolios are an excellent place to start.
If that sounds too complicated, find a target date fund and put all your money there.
4 Things to Know Before Rolling Over
Here are four final things to think about before you do a 401(k) rollover to an IRA.
- Using an already established IRA. If you already have an IRA, you’ll probably want to roll over the 401(k) money into that same IRA. It’s cleaner to have one retirement account, especially if you like the investment options in your IRA.
- Are there any fees? Check with your old employer’s 401(k) administrator to see if you have fees when rolling over the money to an IRA. There shouldn’t be, but your plan may have some uncommon rules. You may have to forfeit some of your employer match, for example.
- Maintain the same type of account. If your old employer had a Roth 401(k), which is not as common as a traditional 401(k), you should roll over into a Roth IRA. Otherwise, if you had a traditional 401(k), you should roll over into a traditional IRA. This is the best way to avoid an odd tax situation.
- You have 60 days. If your old 401(k) plan administrator handed you a check for the rollover distribution, you have 60 days to deposit the money into your new IRA. Don’t miss the 60-day deadline, or you’ll owe significant taxes and penalties.
Other Options for Rollovers
You do have other options beyond rolling over the money into an IRA. Some of these options may work better for your particular situation.
Leave the Money Where It Is
If your employer’s 401(k) plan administrator allows former employees to keep their 401(k) money in the plan, you can choose to do nothing. This isn’t always the case, as some plans require former employees to move the money out of the plan within a certain time frame after the final day on the job.
If you have a certain amount in your 401(k) account, usually at least $5,000, your former employer may allow you to keep the money where it is. This is beneficial to the plan administrator, as the plan’s overall balance remains higher. It also generates less paperwork for the administrator.
Keeping the money where it is can be a benefit to you, especially if you will not be jumping directly into a new job, or if your new employer doesn’t offer retirement benefits.
The downside is the plan could make significant changes to the investment options it offers, and you may not receive immediate notification, which may leave your money in a bad investment. And if your old employer goes into bankruptcy or is sold to another company, your 401(k) money could become inaccessible for a few months to a couple of years.
Take the Money to the New 401(k)
You have the option of sending the entire balance to your new employer’s 401(k) plan. For some, having all of the retirement money in one account is the easiest option to manage.
If you have the ability to borrow against your 401(k) balance for things like home purchases, moving your old employer’s 401(k) account into your new employer’s 401(k) account is a beneficial idea. Having a higher balance in a single 401(k) account is a benefit versus having your retirement money spread across a few accounts with smaller balances in each one.
When getting a new job with a great 401(k) plan, this is an excellent option.
You’ll rarely see anyone recommend that you take the cash out of your old 401(k) account when you switch jobs. The penalties and tax hit you will have make this a poor financial choice for most people.
You may have to pay a 10% penalty to the IRS on the entire balance, and you may have to pay taxes on the balance at your current income tax rate. The IRS may waive the penalties if you have excessive medical costs that you need to pay or if you have a disability.
If you are not working after you leave one job, meaning you will have a low income tax rate, and you need the money to function, you may be able to justify the hit when cashing out your 401(k). But it just isn’t a good idea except under extreme circumstances.