How to Roll Over Your 401k

Rolling over a retirement fund into an IRA, Roth IRA or another 401k is easy if you follow these steps.

Starting a new job is stressful: new coworkers, new job duties, new coffee machine and — if you’re at a decent company — new options for a 401k, the workplace savings plan that lets employees make tax-free contributions directly from their paychecks.

Most workers want to roll over a 401k when they switch jobs because they already have a 401k with a previous employer, and then have to enroll in a new plan with their new employer. Instead of trying to maintain multiple 401k accounts, you can consolidate your 401k savings so that you can better manage your investments.

Here are a few 401k rollover options to consider if you find yourself in a similar situation.

Read: 10 Ways to Increase Your 401k

What to Consider Before You Roll Over Your 401k

A 401k grows tax-free until your retirement, but when you withdraw the money it is taxed as income. However, if you withdraw during retirement, you will be taxed at a lower rate. One bonus of a 401k is that many employers match an employee’s contribution to some degree.

A 401k rollover refers to transferring tax-protected retirement savings from one account to another — generally, from an old employer-sponsored account to a new one. Americans typically complete a 401k rollover after switching jobs. Before you decide to roll over your 401k to your new company, consider a few factors.

Fees

Find out what fees are involved to roll over your 401k. Some fees will be required, so make sure that they aren’t high and won’t cost more than you want to spend. Also, whether the new 401k is run by a bank, mutual fund or insurance company, most providers will try to sell you more expensive products. To know exactly what you’ll be charged, ask about any expenses related to the 401k, including:

  • Administrative fees
  • Investment management fees
  • Commission fees

Maximum Contributions

The maximum contribution you can make to a 401k in 2016 is $18,000. It’s important not to overcontribute. If you contribute more money than the maximum allowed, you could pay taxes twice on your contribution amount: during the year you overcontributed and in the year the excess amount is returned to you.

Related: What Are the Maximum 401k Contribution Limits for 2016?

Choosing New Investments

If you roll over your old 401k to a new 401k plan or into an individual retirement account, you’ll have to pick new investments. Choosing new investments can be a daunting task, so speak with a financial advisor or do research to ensure that you understand what you’ll be investing in with your new account.

How to Roll Over Your 401k

Once you change jobs you have at least 30 days to figure out what to do with the old 401k funds. The worst move you can make is to switch from a low-cost, diversified 401k to a high-fee, commissioned IRA since your goal is preservation of your nest egg, according to Forbes. To help you figure out what strategy is best for your account, take a look at the different ways to roll over a 401k.

At a New Job

When you start a new job, you have the opportunity to move the 401k funds you had at your previous company to the new company’s 401k. By directly rolling over your account this way, you can avoid taxes and penalties.

  1. Contact the 401k administrator at your new job for the new account address, which would be the plan name and your name.
  2. Provide your former employer’s 401k administrator with this new account address.
  3. Confirm that money will be transferred directly from your old plan to the new plan.
  4. Ask for confirmation once funds have been directly transferred.

Into an IRA

You can roll over your 401k into an IRA by following a few steps:

  1. Contact your former 401k administrator to let them know that you’re rolling your 401k to an IRA, often called a traditional IRA.
  2. The financial company that will be holding the new IRA should then contact the old 401k administrator for paperwork to proceed with the rollover.
  3. Choose your new investments.

Into a Roth IRA

The steps for rolling over to a Roth IRA are similar to those for rolling over to a traditional IRA:

  1. Contact your old 401k administrator to let them know that you’re rolling over your 401k to a Roth IRA.
  2. The financial company that holds your Roth IRA should contact your old 401k administrator to complete paperwork to proceed with the rollover.
  3. Choose new investments.

One of the biggest differences between traditional IRAs and Roth IRAs is when money must be withdrawn: With a traditional IRA you must start taking money out at age 70.5 years old; with Roth IRAs, you are not required to withdraw your funds at any particular age, even when you retire.

Moreover, if you decide to roll over into a Roth IRA from a 401k, this is considered a Roth conversion and you’ll pay taxes. If you roll over your 401k to a traditional IRA, however, you won’t have any federal income tax consequences.

Read: How to Choose Between the Different Types of IRAs

Alternatives to a 401k Rollover

You aren’t required to roll over your 401k to another investment account when you start working at a new company. What you do with your retirement investments is up to you. Here are a couple alternative options to rolling over your 401k.

Leave Your 401k in Your Previous Employer’s Account

When you leave a job, you should check your old employer’s rules for retirement plans for former employees. You might have the option to keep your 401k account active even though you’re no longer an employee there. Keeping your 401k active with your previous employer could be a good option if you’re satisfied with that plan, like the investment options that are unique to that plan, or if you just don’t know what you want to do with your money.

Some possible disadvantages could exist with this option, though, including:

  • Inability to make new contributions
  • Fewer investment options and withdrawal options
  • Inability to withdraw partial amounts

Cash Out

Cashing out your 401k could be tempting during a cash flow shortage — to which you might be especially susceptible when changing jobs. However, if you decide to cash out before 59.5 years of age, the money you withdraw will be subject to a 10 percent penalty plus the regular income tax.

Any early withdrawal from a 401k will be costly. Take the following hypothetical situation in which you cash out $50,000 from your 401k. You would end up losing:

  • 25 percent federal marginal income tax: $12,500
  • 7 percent state income tax: $3,500
  • 10 percent early withdrawal penalty: $5,000

By cashing out early, you would end up paying $21,000 in taxes and fees, and taking home only $28,000 of your hard-earned savings.

Cashing out early is not recommended; there is no way to avoid a 401k penalty if you withdraw your money early. Plus, you’ll lose out on compound interest and have to start saving again from scratch. Only in extremely tough financial situations should you consider withdrawing early from your 401k.

Keep Saving Your 401k

Deciding what to do with a 401k plan when switching jobs can be difficult. You’ll have to carefully consider your options to figure out whether rolling over to a new 401k or other kind of retirement account is best for you. The most costly option would be to cash out your 401k; cashing out should be reserved for extreme situations only. Whatever route you decide to take with your 401k, make sure you research your options thoroughly — your future depends on it.