Is a 401(k) rollover the right move for your financial game plan? Here are some key steps to start your rollover by finding the right spot for your money without incurring taxes.
First, what is a 401(k) rollover?
When you move money to an IRA from an old employer-sponsored plan like a 401(k), that is what is called a 401(k) rollover. If you have an old 401(k) from changing jobs, you may choose to do a 401(k) rollover.
Next, what are the options for an old 401(k)?
There are four main options to choose from when considering what to do with your 401(k). It is essential to understand the tax implications before making a decision. The four options are:
- Hang on to your old 401(k) with your former employer
- Cash out your 401(k) (beware that there are taxes and penalties)
- Rollover your old 401(k) into an individual retirement account (IRA)
- Roll your old 401(k) into a new employer’s 401(k) plan
Leave your old 401(k) with your previous employer
If you change jobs, you can have your 401(k) account managed by your former employer by choosing to allow the employer to continue managing the retirement assets by leaving the account where it is.
You can choose to do this if you have a substantial amount in your retirement account. Financial advisors say that you must have at least $5,000 invested in your 401(k) account if you want to leave it with the former employer.
The 401(k) balance must be from your earnings from that employer. Any funds you have rolled over from previous employers are not included in determining the qualified 401(k) balance.
If your 401(k) balance is more than $1,000 but less than $5,000, the employer will transfer the 401(k) assets to its choice of IRAs.
After the employee leaves, the transfer from the 401(k) to the new retirement account can take up to 60 days. If the 401(k) balance is below $1,000, the employer will automatically cash out the money and send a balance payment to the former employee in a check.
Cash out your 401(k)
Another option you may choose is to cash out your 401(k). However, that can come at a high price. You can request that your former employer pays you with a check, but they can withhold 20% to pay taxes for your distribution.
This means you incur a 10% penalty and will potentially be taxed unless the distribution is considered a “qualified” one.
401(k) rollover into an IRA
The main advantage of rolling over your 401(k) into an IRA is that you sometimes have lower fees and more investment choices. Typically, the 401(k) money must be put into a new IRA account within 60 days if you decide to do a 401(k) rollover into an IRA.
When rolling over a 401(k) into an IRA, the following steps are essential: Choose which type of IRA account roll your 401(k) into; open the new IRA, and remember the 60-day rule or ask your 401(k) plan for a direct rollover.
Indirect rollovers are also possible choices for your 401(k) instead. This means that you can withdraw the money and give it to the chosen IRA provider. However, this may cause complex tax issues, and a direct rollover may be more straightforward.
To get back the 20% the plan administrator withheld to pay taxes, you must deposit the complete account balance to your IRA, including the withheld amount, within 60 days of the distribution date.
Then, the IRS will see that you rolled over your entire retirement account and then refund you the withheld amount at tax time.
Rollover your 401(k) to a new employer
If you prefer to keep your money all in one location, you may transfer assets from your old 401(k) plan with your former employer to your new employer’s 401(k) plan.
This move will make it easier for you to communicate with your new employer about your retirement investment and see how your assets are doing.
When you want to roll over one 401(k) account into another, you need to contact the plan administrator at your former employer and ask if they can do a direct rollover.
“Direct rollover” means that your old 401(k) plan directly gives a check into your new 401(k) account. You do not receive the money. It goes from one to another.
Typically, there aren’t tax penalties associated with 401(k) rollovers if the money goes directly from the old account into the new one.
Although having all of your investments in one place may keep your financial life organized and with fewer accounts to monitor, ensure that your new 401(k) isn’t incurring higher account fees and that the options are right for you.