If you change jobs, or even if you don’t, you can keep your 401(k) where it is, cash it out, or roll it over. There are plenty of reasons to roll over an employer-based retirement plan — to consolidate far-flung accounts, because your current plan’s fees are too high or its options are too few, or, of course, because you got a new job with a new 401(k) plan.
No matter the reason, the things you do or don’t do could literally affect the rest of your life and your ability to retire comfortably. Follow this guide to rolling over your retirement plan the right way.
1. Choose Your New Account Type
Step one is to decide whether you’re rolling over some or all of your savings from your old 401(k) and which kind of tax-advantaged retirement account you want to move it to. No matter the account type, you want to make sure your new plan provider offers a wide variety of low-cost funds with no administrative fees, according to Forbes. Here’s a look at your options:
- 401(k)-to-401(k) rollover: If you change jobs, transferring your existing 401(k) directly to your new employer’s plan is usually the easiest and most direct option, provided your new employer’s plan allows transfers.
- 401(k)-to-individual retirement account (IRA) rollover: If you’re moving on to self-employment, if your new employer doesn’t offer retirement benefits, or if it does, but it has high fees, limited fund choices, or no company match, an IRA might be right for you. Like 401(k)s, IRAs hold pre-tax income — you pay taxes on them later when you make withdrawals in retirement.
- 401(k)-to-Roth IRA rollover: Unlike 401(k)s and IRAs, Roth IRAs hold after-tax money. Since your funds have already been taxed, you can make withdrawals in retirement tax-free — but you don’t have to wait that long if you want your money sooner. Roth IRAs are much more flexible and don’t impose the strict rules associated with 401(k)s and traditional IRAs. You can pull from them before you reach retirement age without being hit with early withdrawal penalties, and Roth IRAs don’t come with the required minimum distributions (RMDs) that make you start taking withdrawals from IRAs and 401(k)s at age 72.
2. Decide Where and How You’ll Invest
If you’re moving your money to a different employer-sponsored 401(k), you’ll be limited to the funds that are offered within that plan — but the trade-off for fewer options is simplicity. 401(k)s can be the easiest option, particularly for newer or hands-off investors, as funds are often based on factors like your tolerance for risk or projected retirement year. Another benefit, according to Forbes, is that you can contribute much more money to a 401(k) than you can to either kind of IRA, and 401(k)s offer better protection in case of bankruptcy.
If you convert your 401(k) to an IRA or a Roth IRA, on the other hand, you’ll have more options, but you’ll also have more choices to make on your end. If you’re a DIY investor who wants to avoid all fees and pick your own stocks and ETFs, your best bet is a truly free broker like M1 Finance, which offers key features like partial-share trading, automatic investing, dividends reinvestment, and margin lending.
If you want more of a 401(k)-style experience with plans based on your risk profile or your retirement target date, you might instead open an IRA or Roth IRA with a robo-advisor like Betterment or SoFi.
3. Understand the Rules, Procedures and Tax Implications
The simplest and easiest way to transfer funds is through a direct transfer, also called a trustee-to-trustee transfer, according to Forbes. In this case, your current provider will wire your money directly to your new 401(k) or IRA administrator. If one or both parties don’t allow direct transfers, you’ll have to do an indirect transfer, which is rarely the better of the two options.
With indirect transfers, your 401(k) provider will liquidate your account and send you a check — minus 20%, which the IRS requires your employer to withhold — which you’ll then deposit into your new account. You must deposit the check within 60 days or the IRS will treat it the same as an early cash-out and you’ll be hit with harsh penalties and taxes.
If you roll over your existing 401(k) into a new 401(k) or into a traditional IRA, you won’t have to pay any taxes on the rollover amount, according to the Financial Industry Regulatory Authority (FINRA), because those kinds of accounts are funded with pre-tax earnings. If you roll over a 401(k) to a Roth IRA, on the other hand, you will have to pay taxes on the funds that you convert.
4. Initiate the Rollover
You may or may not have to pay a fee to roll over a 401(k), but either way, the process is fairly straightforward:
- If you’re rolling your 401(k) over to a new employer’s plan, contact your new employer’s human resources rep or the plan’s administrator and request a direct transfer.
- If you’re converting to an IRA or Roth IRA, the first step is to open an account with the brokerage or robo-advisor of your choice so an active account will be ready to receive your rollover.
- Inform your current 401(k) administrator of your intent to roll over and the name of your new provider.
- Each provider has its own process and procedures. Your new brokerage, bank or robo-advisor will issue you instructions. Follow them exactly, expect to fill out some paperwork, and prepare for some potentially frustrating back-and-forth with both parties.
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