When I left my first big-kid job for a new job, I was super intimidated by the prospect of moving my retirements savings. I left that puppy in my employer-sponsored 401(k) plan for almost two years because I was too scared to do anything with it. (Don’t do that.)
But once I figured it out, it wasn’t too bad. True, there were some phone calls, some paperwork, and even a notary. In the end, though, I was able to roll over my 401(k) funds into a new IRA.
Now I’m seeing more significant gains than when it was in my former employer’s plan. Here’s why and how I did it.
What does it mean to “roll over” your 401(k)?
Rolling over your retirements funds means you move your funds from an employer-sponsored 401(k) plan into a different plan. Most commonly, people transfer funds directly to their own
Individual Retirement Account (IRA) or a new employer’s 401(k) plan.
Why rollover your 401(k) retirement funds
Before you start your rollover process, it’s important to understand the “why.”
Less plans to keep track of
Today, Millennials are job-hopping more frequently than older generations—6 in 10 Millenials are open to new opportunities. Imagine if, after each job you left, you keep your funds in that employer-sponsored plan. You might end up with 12+ 401(k)s to keep track of when you retire!
Avoid administrative fees
A typical 401(k) plan charges fees for each fund, administration fees, etc. Your new employer’s 401(k) might charge fewer fees (or more). But an IRA will almost certainly cost less. Plus, with an IRA, you may have more investment options for buying individual growth stocks and low-risk
Exchange Traded Funds (ETFs). It’s tax-free and penalty-free
A 401(k) is great because it reduces your taxable income and takes advantage of any employer match. Depending on how you do a rollover, you don’t necessarily have to pay taxes or penalties. In contrast, if you cash out your 401(k), you would pay about 20% of those funds in tax withholding, AND you pay the IRS a 10% early withdrawal penalty.
Rollover options
Traditional IRA
When you roll over funds into a traditional IRA, all your tax-deferred earnings can still grow, and you don’t pay income tax on the funds that you roll over until you retire. You’ll also have more control and options to buy (almost) whatever stocks, bonds, or mutual funds you want.
An IRA also allows you to consolidate some retirements assets. So, instead of having multiple 401(k) plans, you have one IRA to manage. And as long as you keep working, you can continue to contribute money to your IRA, up to your contribution limits. (For 2021, people younger than 50 can’t contribute more than $6,000 for a traditional or Roth IRA.)
Roth IRA
If you don’t mind paying taxes upfront on your 401(k) funds, you can choose to roll them over into a Roth IRA. That will be a bit of a shock the year you do the rollover, but you’ll save money in the long run as your funds grow tax-free and are withdrawn tax-free.
Also, you don’t need to take any minimum distributions from Roth IRAs like you would from a 401(k) or traditional IRA. So if you don’t need it, that money can continue to grow in a Roth IRA well into your 70s.
If you’re overwhelmed with investment choices, need access to a financial advisor, or want options to buy discounted company stock, you might prefer rolling over your funds to your current 401(k).
Direct rollover
This means that your 401(k) administrator transfers your funds directly to your new retirement account. You’ll have to be very careful with providing the correct name and information to your 401(k) administrator, so the funds end up in the proper account.
Indirect rollover
In this case, your 401(k) administrator writes you a check for your funds. Then you turn around and reinvest those funds in a qualified retirement account. To avoid paying taxes, make sure you deposit your funds within 60 days.
Annuities
Some people choose to roll over their funds into an annuity, an insurance product that provides guaranteed income. This can carry some extra fees, though, and some additional risks. For example, sometimes, you can’t pass on any money to a beneficiary when you die. Think carefully before you choose this option.
Taxable brokerage account
If your 401(k) holds any employer stock in a publicly-traded company, you might consider withdrawing it and putting it in a taxable brokerage account instead of rolling it over. You’ll pay income tax on the stock based on what it was worth when you got it. But later, when you sell it, the net unrealized appreciation (NUA) will be taxed as a capital gain, which is generally cheaper than income tax.
Steps to rollover your 401(k)
The process for rolling over your 401(k) funds may vary slightly depending on your former employer, their plan administrator, and your new account. I’ve done it twice so far, and these are the steps I followed.
Before you do anything, you should figure out what you’ll do with the funds in your retirement account. Do you want to move them into a new employer’s 401(k) or your own IRA? When you retire, do you want those funds to be taxed as ordinary income or not taxed at all?
You’ll want to ask when you can request a rollover. For example, I’ve had to wait 45 days after my last official day on the job before I could request my funds and close my account. You should also ask about any specific paperwork you’ll need to submit.
Open a new account, if you don’t have one already
If you don’t already have an existing 401(k) or IRA account where you’ll be rolling your funds, now’s the time to open your new account. Be sure to ask about their process for receiving rollover funds, where the funds should be sent, when you can expect the funds to be available, etc.
Sign and submit the paperwork
The first time I did this, my spouse had to sign the form before a notary. This was inconvenient for us, but luckily someone in the HR office was able to help us. Credit unions and banks can usually help, too.
Invest your funds
Once your funds are deposited into your account and available to invest, it’s time to determine your asset allocation. That means what percentage you’ll invest in stocks vs. bonds. Generally, people in their 30s should keep 70% of their funds in stocks. That’s because stocks will give you higher rates of return than bonds.
Costs
Moving money around usually takes – you guessed it – money. While the cost to rollover should cost nothing, the account you’re rolling it into might charge annual administrative fees, regular maintenance fees, or commission on each trade. Compare before you proceed.
The average 401(k) charges fees that amount to 0.45% of the total invested assets. Which can eat up your gains! By contrast, you can avoid fees altogether when opening a self-directed rollover IRA account at Ally Bank.
Pros/Cons
You’ll gain more control over your funds and expand your investment options.
You won’t forget about it as you change jobs.
You may save money by paying fewer fees and maybe even fewer taxes.
You might rush into an account that isn’t better.
You might pay more taxes upfront or be hit with penalties if you’re not careful.
It’s an annoying, tedious process.
The bottom line
Saving money in a 401(k) account is a great way to save for retirement. You can reduce your taxable income, your money grows tax-free until you retire, and you generally don’t have to worry about your funds because someone else is managing them.
When it’s time to leave a job, you may want to consider rolling over your 401(k) funds into a new or existing IRA. The fees are usually cheaper, and you’ll have more control over your investments. If you want a similar tax experience as a 401(k), opt for a traditional IRA.
Or, if you don’t mind paying your taxes on that income now, go with the Roth IRA. When in doubt, though, you should talk with your tax advisor about the tax implications of any choice you make.
