Forty-seven million. That’s how many people left their jobs in 2021 at the height of the Great Resignation. And millions more are planning to quit this year.1
While there’s nothing wrong with blazing new career paths, many of those folks are leaving a trail of forgotten 401(k)s, sometimes with thousands of dollars in retirement savings left behind. Maybe you’re one of them!
If you’ve got money gathering dust in a long-forgotten retirement account, it’s time to find it a new home. That’s where a 401(k) rollover comes in.
What Is a 401(k) Rollover?
A 401(k) rollover simply allows you to transfer your retirement savings from a 401(k) you had at a previous job into an IRA or the 401(k) at a new job. And you won’t have to pay any taxes on the money you transfer (in most cases).
Rolling Over a 401(k): What Are Your Options?
Let’s say you’re starting a new job and you’re wondering what to do with the money in a 401(k) you had at an old job. You have four options:
- Option 1: Cash out your 401(k).
- Option 2: Do nothing and leave the money in your old 401(k).
- Option 3: Roll over the money into your new employer’s plan.
- Option 4: Roll over the funds into an IRA.
We’ll walk you through the pros and cons of each one:
Option 1: Cash out your 401(k).
Let’s get this out of the way—this is the worst thing you can do with your old 401(k).
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If you withdraw the money from your 401(k) plan and take a direct cash distribution, you’ll have to pay any state and federal income taxes you owe on every last penny. And if you’re under 59 1/2 years old, you can go ahead and add another 10% early withdrawal penalty to your tab.
But the worst part is you’re robbing yourself of the chance to continue earning tax-free or tax-deferred growth on your investments for years, maybe decades. It’s just a bad idea all around, folks.
Option 2: Do nothing and leave the money in your old 401(k).
Now, you could just leave the money in your old 401(k) if you’re really happy with your investments and the fees are low.
But that’s rarely the case. Most of the time, leaving your money in an old 401(k) means you’ll have to deal with higher fees that cut into your investment growth and settle for the limited investment options from your old plan. Most people come out way ahead by doing a direct transfer rollover to an IRA (more on how that works later).
Option 3: Roll over the money into your new employer’s plan.
Rolling your money over to your new 401(k) plan has some benefits. It simplifies your investments by putting them in one place. And you also have higher contribution limits with a 401(k) than you would with an IRA—which means you can save more!
But there are lots of rules and restrictions for rolling money over into your new employer’s plan, so it’s usually not your best bet. Plus, your new 401(k) plan probably only has a handful of investing options to choose from too. And if you’re feeling iffy about those options, why put all your retirement savings there? Which brings us to . . .
Option 4: Roll over the funds into an IRA.
Most of the time, transferring the money from your old 401(k) into an IRA is your best option. That’s because an IRA gives you the most control over your investments.
You see, an IRA gives you potentially thousands of mutual funds to choose from. You can pick from the best of the best instead of just a few so-so options. You can work with an investment professional who can walk you through the rollover and help you manage your investments for the long haul—no matter where your career takes you.
How to Roll Over a 401(k) Into an IRA
Okay, now it’s time to get the ball rolling! Once you’re ready to do a 401(k) rollover, you can get the money transferred to your new retirement account in just four easy steps:
1. Decide between a traditional or Roth IRA.
The type of IRA you roll your old 401(k) money into will depend on what kind of 401(k) you’re transferring the money from.
In most cases, if you have a traditional 401(k), you’ll probably want to roll the money into a traditional IRA. That way, you won’t have to pay any taxes on the transfer (you’ll pay taxes later when you take the money out in retirement, though).
If you had a Roth 401(k), that’s a different story. You could roll the money you contributed into a Roth IRA completely tax-free and continue to enjoy tax-free growth and tax-free withdrawals in retirement. But your employer’s contributions are treated like traditional 401(k) contributions . . . so that money needs to either be rolled over into a traditional IRA or you can pay the taxes to roll them into a Roth account.
Easy, right? Traditional to traditional, tax-free today. Roth to Roth, mostly tax-free today and tax-free in retirement.
2. Open the IRA account.
Opening a rollover IRA can be as simple as visiting a bank or brokerage firm’s website and filling out an application online. But the best way to start an IRA is to talk with your investment professional. If you don’t have one, our SmartVestor program can help you find a pro in your area who can help you open up an IRA to move the money into.
Side note: If you already have an IRA, you can simply work with your pro to transfer the funds into your existing account—no need to create a new one!
3. Request a direct transfer rollover from your old 401(k).
Remember, you need to ask for a direct transfer rollover from the plan administrator of your old 401(k)—this could be your old employer or a third party. They’ll give you a form to fill out that will usually ask you to provide your contact information and account information for the plan you’re transferring money from and the account you’re transferring the money to.
4. Choose your investments.
When it comes to investing, your IRA or 401(k) is like a grocery bag—and your investments are the groceries that go inside it. Now that you’ve got the ball rolling on your rollover, it’s time to pick and choose what goes inside your bag!
You’ll want to evenly spread out your investments between four different types of growth stock mutual funds:
- Growth and income (or large-cap) funds
- Growth (or mid-cap) funds
- Aggressive (or small-cap) growth
- International funds
Look for funds that have a long track record of strong returns, meaning the fund is at least 10 years old and regularly outperforms other funds in its category. Once you’re all set up, remember to continue investing 15% of your income for retirement so you can keep your nest egg growing!
What Are the Advantages of a 401(k) Rollover?
At the end of the day, a 401(k) rollover makes your life a whole lot easier and simpler in three huge ways. And when it comes to investing, you definitely want to keep it simple!
1. You can manage all your investments in one place.
A recent study found that the youngest baby boomers worked 12 different jobs over the course of their careers.2 Did you hear that? Twelve! Imagine how difficult it is to keep track of a dozen 401(k)s from previous jobs.
The more scattered your retirement accounts are, the harder it is to make good decisions about your investments—and that can affect your retirement future. You’ll be able to manage your retirement funds better by having them all in one place.
2. You’ll have more investment options to choose from in an IRA.
The more investment options you have, the more likely you are to make better decisions. That’s why Dave likes to say if you have two bad options in front of you, go look for better ones!
Like we mentioned before, rolling your old 401(k) funds into an IRA means you have thousands of mutual funds to choose from instead of the handful of options you had in your old workplace plan.
3. You’ll have more control over your investments.
If you already have an investment professional, a 401(k) rollover allows you to move those funds into an account that’s already under their management. That way, you can work closely with your advisor to invest that money the way you want to.
Get Help With Your 401(k) Rollover
Having an investment professional in your corner, someone who can help you find the right investments to add to your portfolio and walk you through all the ins and outs of a 401(k) rollover, makes this process a lot easier.
Don’t have an investment professional? No worries! Our SmartVestor program can get you in touch with someone in your area to help you get started.
Frequently Asked Questions: 401(k) Rollover
Still have questions about your 401(k) rollover? Don’t worry, we have answers for you!
Is a 401(k) rollover worth it?
Absolutely! Like we’ve already mentioned, rolling over a 401(k) into an IRA gives you more investment options to choose from, makes it easier to manage your retirement funds, and usually offers you lower fees than leaving your money in your old 401(k) account.
How long do I have to roll over my 401(k) from my old job?
If you have money sitting in a 401(k) with your last employer and you decide to leave the money in there, there’s no time limit. You can roll those funds into an IRA or your new employer’s retirement plan whenever you want to.
However, if you have your old 401(k) money sent directly to you from your retirement plan (huge mistake, by the way—don’t do it!), the IRS says you have just 60 days from the date you receive a retirement plan distribution to roll it over into another plan or an IRA. Otherwise, you will get hit with taxes and an early withdrawal penalty.
Do I have to pay taxes when I roll over a 401(k)?
It depends on whether or not you’re changing account types with the rollover. For example, if you move funds from a traditional 401(k) to a Roth IRA—that’s called a Roth conversion—then you will owe taxes on the money after the transfer. And that could create a hefty tax bill!
But if you’re transferring money from a traditional 401(k) to a traditional IRA, then you won’t owe any taxes on that rollover. The same goes for a rollover from a Roth 401(k) to a Roth IRA (except for your employer’s contributions, which will be subject to taxes if you roll them into a Roth).
If you have questions about whether your 401(k) rollover counts as a “taxable event,” get in touch with a tax advisor.
When does a Roth conversion make sense?
A Roth conversion, which happens when you roll over money from a traditional 401(k) into a Roth IRA, comes with good news and bad news.
The good news is that from now on, that money will grow inside your Roth IRA tax-free and you won’t pay any taxes on that money when you’re ready to withdraw from the account in retirement.
But when you transfer that pretax money from your traditional 401(k) into a Roth IRA, which is funded with after-tax dollars, you’ll have to pay taxes on that money now. That’s the bad news.
A Roth conversion might feel like ripping off a Band-Aid now, but it’ll feel great once you retire. You might want to seriously consider a Roth conversion only if you can afford to pay the tax bill with cash you have saved up. But be careful, because a conversion could add thousands of dollars to your tax bill. If that’s just too much for you to stomach, then stick with a traditional IRA rollover.
Direct Rollover vs. Indirect Rollover: What’s the Difference?
Okay, once you decide to roll money from one account to another, you have two options on how to do the transfer: a direct rollover or an indirect rollover. Spoiler alert: You always want to do the direct transfer. Here’s why.
With a direct rollover, the money in one retirement account—an old 401(k) you had in a previous job, for example—is transferred directly to another retirement account, like an IRA. That way, the owner of the account (that’s you) never touches the money, and you won’t have to pay any taxes or penalties on the cash being transferred. Once it’s done, it’s done!
Indirect rollovers, on the other hand, are a bit more complicated—and needlessly risky. In an indirect rollover, instead of the money going straight into your new account, the cash goes to you first. Here’s the problem with that: You have only 60 days to deposit the funds into a new retirement plan. If not, then you’ll get hit with taxes and penalties.
See why the direct rollover is the only way to go? There’s just no reason to take a chance on an indirect rollover that leaves you open to heavy taxes and penalties. That’s just dumb with a capital D!
This article provides general guidelines about investing topics. Your situation may be unique. If you have questions, connect with a SmartVestor Pro. Ramsey Solutions is a paid, non-client promoter of participating Pros.