Can You Transfer Your 401(k) to a CD? How To Avoid Penalties

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If you’re nearing retirement, you might be wondering what you should do with your work 401(k) once you leave your job. Or maybe you have an old 401(k) from a previous employer that’s just sitting there, but you want to roll it over into a safe investment like a certificate of deposit (CD).

But are you allowed to rollover a 401(k) into a CD?

While it is possible to move your 401(k) investments into a CD account, there are some specific steps you must take to avoid a surprise tax bill from Uncle Sam. Plus, there are several types of accounts to choose from, so here’s a breakdown of each option to help you choose the right move for your 401(k) funds.

What Is a 401(k) Rollover and How Does It Work?

Rolling over your 401(k) account is simply a transfer of your funds from one account to another. There are several things you can do with your 401(k) when you leave your job, including:

  • Leaving it in place: You can leave your old 401(k) in place and it will stay invested in whatever funds you have chosen. But you may also be charged maintenance and management fees, and your investment selection is limited to whatever is available in that account.
  • Rolling it into another workplace retirement account at your new job: If you change jobs, you usually have the option of rolling your old 401(k) over to the new job’s retirement account. This helps keep your retirement funds in one place so you don’t forget about them, but remember, you’ll need to choose new investments from your new 401(k) custodian.
  • Rolling it into an individual retirement account (IRA): A popular option is to roll your 401(k) into an IRA account. This gives you the most flexibility of investment choices, as well as lower fees than most workplace retirement accounts.
  • Cash it out: If you cash out your 401(k) from your old job, you’ll be hit with a tax bill for the entire amount, and if you’re under age 59.5, you’ll pay an additional 10% penalty. Cashing out your 401(k) early is usually not recommended.
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To roll over your funds, you typically need to contact your 401(k) provider and ask them what documentation is needed. This may include authorization forms from your new provider to access your 401(k) funds and transfer details to tell your old provider where to send the funds.

It may take some time to complete the 401(k) rollover, so keep an eye on your accounts and stay in contact with your old 401(k) provider if it takes longer than two weeks. 

Can You Transfer Your 401(k) to a CD?

Yes, you can transfer a 401(k) to a CD, but there are some requirements to follow to avoid taxes and penalties. You’ll need to make sure to use an IRA CD, which is a retirement account that only allows you to invest in a CD.

IRA CDs are CDs that are held in an IRA account, allowing you to save on taxes. You can choose a traditional or Roth IRA CD account, depending on your preference for tax treatment. You can also open a regular IRA account that offers CD investments inside of it. Large brokers like Fidelity allow you to invest in a CD within a regular IRA.

Here are a few limitations to be aware of when investing in an IRA CD or regular IRA account:

  • Unlike a regular CD account, IRA contributions are capped to an annual limit of $6,500 — or $7,500 is age 50 or older. This does not apply to rollovers.
  • You cannot access the funds in your IRA CD before retirement age — currently age 59.5 — without penalty.
  • If you roll over into a traditional IRA CD account, there are no taxes to be paid.
  • If you roll over into a Roth IRA CD account, you will need to pay taxes on the entire amount, as Roth accounts are “post-tax” retirement accounts.
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How To Avoid Penalties When Transferring Your 401(k) to a CD

If you want to transfer your 401(k) to a CD and don’t want to pay IRS penalties, here are the steps you need to take:

  1. Choose an IRA account to open. Pick a broker and an IRA CD account.
  2. Start the rollover. Most IRA accounts let you choose a rollover option when opening your account. This offers you the option to fund your new CD using a transfer from your 401(k) account. Complete the application, and you should be given next steps from your broker.
  3. Talk to your 401(k) custodian. You’ll need to talk to your current 401(k) account custodian to figure out what documentation and steps are needed to complete the rollover. You will also need to give them info on where to transfer the funds.
  4. Wait. Once you’ve submitted the required documentation to initiate the rollover, your 401(k) custodian will process it and transfer the funds. This can take several weeks.

You can also have the funds send to your own account, but if you don’t redeposit them within 60 days to a new retirement account, the entire withdrawal will be taxable — and if you’re under age 59.5, you’ll be hit with a 10% penalty. This is why a direct rollover is recommended over transferring the funds yourself.

Also, if you choose to rollover your 401(k) funds into a Roth IRA, you will avoid penalties, but the entire amount will be taxable. This is because traditional 401(k) accounts are pre-tax, while Roth accounts are post-tax. Check with your custodian to understand if your account is traditional or a Roth account, and make sure your IRA CD account type matches to avoid an unexpected tax bill.

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Is a CD a Good Investment for Retirement?

CDs are currently offering a high interest rate due to the recent increases in the Federal Funds Rate. Some CDs are offering up to 5% interest, which is a solid return for a retirement account. And CDs are safe investments that are FDIC-insured and do not pose a risk of loss.

But CDs may underperform other investments, such as stocks, index funds or other mutual funds. Over the long-term, CDs have a lower average return — and with the effect of compound interest, you could be losing out on thousands upon thousands of dollars in retirement.

Plus, CDs are short-term investments, with common durations ranging from 12 months to 5 years in length, but as they mature, you’ll need to reinvest in another CD. If the interest rates have dropped, those returns will be lower than your previous CD rate, which is not great for long-term investing.

If you are looking for a short-term place to park cash in an IRA account for retirement, a CD can be a great option. But if you’re rolling over a large 401(k) balance that is part of your long-term investment strategy, you might want to consider diversifying your holdings among other assets, as well.

Bottom Line

You can rollover your 401(k) account into a CD without any penalties or taxes. But you need to make sure you’re rolling over into an IRA CD, specifically. And always ensure to roll over into a like-kind account, whether a traditional or Roth retirement account, or you might get hit with a surprise tax bill.

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