Rolling Over Your 401(k) to an IRA
Keeping the Current 401(k) Plan
Rolling Over to a New 401(k)
Cashing out Your 401(k)
Don’t Roll Over Employer Stock
How to Do a Rollover
The Bottom Line
When you leave an employer for non-retirement reasons, for a new job, or to be on your own, you have four options for your Rolling Over Your 401(k) Plan.
Let’s look at each of these strategies to determine which is the best option for you.
You have the most control and the most choice if you own an IRA. Unless you work for a company with a very high-quality plan—these are usually the big, Fortune 500 firms—IRAs typically offer a much wider array of investment options than 401(k)s for an IRA rollover chart.
Some 401(k) plans have only a half dozen funds to choose from, and some companies strongly encourage participants to invest heavily in the company’s stock. Many 401(k) plans are also funded with variable annuity contracts that provide a layer of insurance protection for the assets in the plan at a cost to the participants that often run as much as 3% per year. Depending on which custodian and which investments you choose, IRA rollover chart fees tend to run cheaper.
With a small handful of exceptions, IRAs allow virtually any type of asset: stocks, bonds, certificates of deposit (CD), mutual funds, exchange-traded funds, real estate investment trusts (REITs), and annuities. If you’re willing to set up a self-directed IRA, even some alternative investments like oil and gas leases, physical property, and commodities can be purchased within these accounts.
If you opt for an IRA, your second decision is to open a traditional IRA rollover chart or a Roth IRA. The choice is between paying income taxes now or later.
The main benefit of a traditional IRA is that your investment, up to a certain amount, is tax-deductible now. You deposit pre-tax money into an IRA, and the amount of those contributions is subtracted from your taxable income. The transfer is simple if you have a traditional 401(k) since those contributions were also made pre-tax for rollover IRA into 401k.
Tax deferral won’t last forever, however. You must pay taxes on the money and its earnings later when you withdraw the funds. And you are required to start drawing them at age 72. A rule is known as taking required minimum distributions (RMDs), whether if you’re still working or not. (RMDs are also required from most rollover IRA into 401k (k)s when you reach that age unless you are still employed—see below.)
Previously, RMDs began at age 70½, but the age has been bumped up following new retirement legislation passed into law in December 2019—the Setting Every Community Up for Retirement Enhancement (SECURE) Act.
In contrast, if you opt for a Roth IRA conversion, you must immediately treat the entire account as taxable income. As a result, you’ll pay tax now on this amount (federal income tax as well as state income taxes, if applicable). What’s more, you’ll need the funds to pay the tax and may have to increase withholding or pay estimated taxes to account for the liability.
However, assuming you maintain the Roth IRA for at least five years and meet other requirements, then all the funds—your after-tax contribution plus earnings on them—are tax-free.
If you are wondering whether a rollover is allowed or will trigger taxes, remember this basic rule: You’re generally safe if you roll over between accounts that are taxed in similar ways (e.g., a principal 401(k) rollover to a principal IRA, or a Roth 401(k) to a Roth IRA).
There are no lifetime distribution requirements for Roth IRAs, so funds can stay in the account and continue to grow on a tax-free basis. You can also leave this tax-free nest egg to your heirs. But those who inherit the account must draw down the account over the ten years following your death, as per new rules outlined in the SECURE Act. Previously, they could draw down the account over their life expectancy.
If your 401(k) plan was a Roth account, then it can only be rolled over to a Roth IRA. This makes sense since you already paid taxes on the funds contributed to the designated Roth account. If that’s the case, you don’t pay any tax on the rollover to the Roth IRA. However, doing a conversion from a principal 401 (k) rollover to a Roth IRA is a two-step process. First, you roll over the money to an IRA, converting it to a Roth IRA.
Where are you financially now versus where you think you’ll be when you tap into the funds? Answering this question may help you decide which rollover option to use. For example, if you’re in a high tax bracket now and expect to need the funds before five years, a Roth IRA may not make sense. You’ll pay an increased tax bill upfront and then lose the anticipated benefit from tax-free growth that won’t materialize.
Conversely, if you’re in a modest tax bracket now but expect to be in a higher one in the future, the tax cost now may be small compared with the tax savings down the road (assuming you can afford to pay taxes on the rollover now).
Will you need money before you retire? Remember that all withdrawals from a traditional IRA are subject to regular income tax (plus a penalty if you’re under 59½). In contrast, withdrawals from a Roth IRA of after-tax contributions (the transferred funds you already paid taxes on) are never taxed. You’ll only be taxed if you withdraw earnings on the contributions before you’ve held the account for five years; these may be subject to a 10% penalty as well if you’re under 59½ and don’t qualify for a penalty exception.
It’s not all or nothing, though. You can split your distribution between a traditional and Roth IRA, assuming the 401 (k) plan administrator permits it. You can choose any split that works for you (e.g., 75% to a traditional IRA and 25% to a Roth IRA). You can also leave some assets in the plan.
If your former employer allows you to keep your funds in its 401(k) after you leave, this may be a good option, but only in certain situations. The primary one is if your new employer doesn’t offer a 401(k) or offers one that’s less substantially less advantageous. For example, if the old plan has investment options, you can’t get into a new plan.
Additional advantages to keeping your 401(k) with your former employer include:
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 does protect up to $1.25 million in traditional or Roth IRA assets against bankruptcy. But protection against other types of judgments varies in principal 401k rollover.
If you are going to be self-employed, you might want to stick to the old plan, too. It’s certainly the path of least resistance. But bear in mind, your investment options with the 401(k) are more limited than in an IRA, cumbersome as it might be to set one up.
Bear in mind that if your assets are less than $5,000, then you may have to notify your plan administrator or former employer of your intent to stay in the plan; otherwise, they may automatically distribute the funds to you or a rollover IRA. On the other hand, if the account has less than $1,000, you may not have a choice—many 401(k)s at that level are automatically cashed out.
If your new employer allows immediate rollovers into its 401(k) plan, this move has its merits. You may be used to the ease of having a plan administrator manage your money and to the discipline of automatic payroll contributions. You can also contribute a lot more annually to a 401(k) than you can to an IRA according to principal 401k rollover.
For 2020 and 2021, employees can contribute up to $19,500 to their 401(k) plan. In addition, anyone age 50 or over is eligible for an additional catch-up contribution of $6,500.
Another reason to take this step: If you plan to continue to work after age 72, you should be able to delay taking RMDs on funds that are in your current employer’s 401(k) plan, including that roll over money from your previous account. (Before the new law, RMDs began at 70½).
The benefits should be like keeping your 401(k) with your previous employer. The difference is that you will make further investments in the new plan and receive company matches if you remain in your new job.
Mainly, though, you should make sure your new plan is excellent. For example, if the investment options are limited or have high fees or no company match, the new 401(k) may not be the best move for principal 401k rollover.
Suppose your new employer is more of a young, entrepreneurial outfit. In that case, the company may offer a SEP IRA or SIMPLE IRA—qualified workplace plans geared toward small businesses (easier and cheaper to administer than 401(k) plans). The rollovers of IRA into 401(k) plans do allow these, but there may be waiting periods and other conditions.
Cashing it out is usually a mistake. First, you will be taxed on the money as ordinary income at your current tax rate. In addition, if you’re no longer going to be working, you need to be 55 years old to avoid paying an additional 10% penalty. If you’re still working, you must wait to access the money without a penalty until age 59½.
So, aim to avoid this option except in true emergencies. If you are short of money (perhaps you were laid off), withdraw what you need and transfer the remaining funds to an IRA.
There is one big exception to all of this. If you hold your company (or ex-company) stock in your 401(k), it may make sense not to roll over this portion of the account. The reason is net unrealized appreciation (NUA), which is the difference between the value of the stock when it went into your account and its value when you take the distribution.
You’re only taxed on the NUA when you take a stock distribution and opt not to defer the NUA. Paying tax on the NUA now becomes your tax basis in the stock, so when you sell it—immediately or in the future—your taxable gain is the increase over this amount.
Any increase in value over the NUA becomes a capital gain. You can even sell the stock immediately and get capital gains treatment. (The usual more-than-one-year holding period requirement for capital gain treatment does not apply if you don’t defer tax on the NUA when the stock is distributed to you.)
In contrast, if you roll over the stock to a traditional IRA, you won’t pay tax on the NUA now. Still, all of the stock’s value to date, plus appreciation, will be treated as ordinary income when distributions are taken.
The principals of the 401(k)rollover plan is easy. First, you pick a financial institution, such as a bank, brokerage, or online investing platform, to open an IRA with them. Then, let your 401(k)-plan administrator know where you have opened the account.
IRA rollover chart is explained as direct and indirect. A direct rollover is when your money is transferred electronically from one account to another, or the plan administrator may cut you a check made out to your account, which you deposit. The direct rollover (no check) is the best approach.
In an indirect rollover, the funds come to you to re-deposit. If you take the money in cash instead of transferring it directly to the new account, you have only 60 days to deposit the funds into a new plan. If you miss the deadline, you will be subject to withholding taxes and penalties.
Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.
Because of this deadline, direct rollovers are strongly recommended. Nowadays, you can shift assets directly from one custodian to another in many cases without selling anything—a trustee-to-trustee or in-kind transfer. If, for some reason, the plan administrator can’t transfer the funds directly into your IRA or new 401(k), have the check they send you made out in the name of the new account care of its custodian. This still counts as a direct rollover. However, to be safe, be sure to deposit the funds within 60 days.
Otherwise, the IRS makes your previous employer withhold 20% of your funds if you receive a check made out to you. It’s important to note that if you have the check made out directly to you, taxes will be withheld, and you’ll need to come up with other funds to roll over the full amount of your distribution within 60 days.
Bear in mind, though, if you take a check made out to the new plan but fail to get it deposited within the 60 days, you still get socked with penalties.16 To learn more about the safest ways to do IRA rollovers and transfers, download IRS publications 575 and 590-A and 590-B.
The Bottom Line
When you leave a job, there are three things to consider when you’re deciding if a 401(k) rollover is right for you:
The key point to remember about all these rollovers is that each type has its rules. A rollover usually doesn’t trigger taxes or raise tax complications, as long as you stay within the same tax category.8 That means you move a regular 401(k) into a traditional IRA and a Roth 401(k) into a Roth IRA.
Just be sure to check your 401(k) balance when you leave your job and decide on a course of action. Neglecting this task could leave you with a trail of retirement accounts at different employers—or even nasty tax penalties should your past employer send you a check that you did not reinvest appropriately in time.
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