Why a 401(k) Rollover?
Updated November 19, 2024
Originally posted March 22, 2021
What to Do with Your Old 401(k)
So, you've left your job, whether it's for a new one or retirement. Now, what do you do with your old 401(k) plan?
Avoid Cashing Out
Cashing out your 401(k) is generally a bad idea. It will result in taxes and a 10% penalty for early withdrawal if you're under 59½.
Don't Just Leave It
While you can leave your 401(k) with your former employer, it's not ideal. You won't be able to make further contributions or take loans. Additionally, you may face restrictions and fees as a former employee.
The Power of Portability
One of the significant benefits of a 401(k) is its portability. You have two main options:
1. Rollover to a New Employer's 401(k)
If your new job offers a 401(k) plan, you can directly roll over your old 401(k) into it. This allows you to consolidate your retirement savings and continue contributing.
2. Rollover to an Individual Retirement Account (IRA)
If your new employer doesn't offer a 401(k) or if you prefer more flexibility, rolling over your 401(k) to an IRA is a great option.
Old 401(k) Account
Individual Retirement Account
Investment Choice
Limited options which usually means a few mutual funds.
Most types of investments: mutual funds, individual stocks, bonds, ETFs, REITs, etc.
Fees & Costs
Plan administrator charges an annual fee. This is on top of the fees charged by the funds offered in the plan.
More investment choices gives the investor more control over expense ratios and fees.
Roth IRA Rollover
May or may not allow for direct Roth rollovers.
Yes.
Estate Planning
Usually, the 401(k) balance is paid out in a lump sum which could have major estate taxes imposed on the beneficiary.
Inherited IRAs have more payout options, and will have to be paid out over a longer period of time (10 years).
Communication
Former employees may find it difficult to be updated with plan details, changes, or get in touch with the provider.
Required to contact account holders in a timely manner with material information regarding the investments or account.
Why Rollover to an IRA?
- Investment Choice: IRAs offer a wider range of investment options compared to 401(k)s, giving you more control over your investments and potentially lower fees.
- Roth IRA Rollover: If you have a Roth 401(k), you can roll it over to a Roth IRA. This allows you to continue growing your tax-free retirement savings. You can also convert a traditional 401(k) to a Roth IRA, but you'll pay taxes on the amount you convert.
- No Required Minimum Distributions (RMDs): Roth IRAs don't have RMDs, while traditional IRAs and 401(k)s do. This provides more flexibility in retirement planning.
- Estate Planning: IRAs offer more flexibility in estate planning compared to 401(k)s, allowing for more favorable tax treatment for beneficiaries.
How to Roll Over Your 401(k)
The best way to roll over your 401(k) is through a direct rollover. This involves transferring the funds directly from your old 401(k) to your new IRA.
Avoid Indirect Rollovers
Indirect rollovers, where you receive a check from your old 401(k) and deposit it into your IRA, are more complex and risky. You have a limited timeframe to complete the rollover and may face tax penalties if you don't.
Consult with a Financial Advisor
Before making any decisions, it's advisable to consult with a financial advisor. They can help you understand your options and choose the best strategy for your specific financial situation.
Sources:
- IRS Publication 590-A:
https://www.irs.gov/pub/irs-pdf/p590a.pdf - Investopedia:
https://www.investopedia.com/
By understanding your options and taking the right steps, you can ensure a smooth transition and maximize your retirement savings.