See more from Retirement

Advertiser Disclosure

How Do I Roll Over a 401k to an IRA

Spread the love
DJ Article August 12th

Have you recently left your job and aren’t sure what to do with all of the money you (and your employer) have contributed to your 401k?

One of the awesome benefits of a 401k plan is the options you have with your money when you leave or switch employers. For instance, you could cash it out completely. However, I wouldn’t advise this because then you’d have to pay some pretty hefty taxes and penalties.

You could also move the money into your new employer’s 401k plan. If you prefer, you can leave it right where it is in the old plan. Either option is fine, but this could lead to some unnecessary expenses and pose some limitations when it comes to your investment options.

Speaking from personal experience, there’s one option that stands out among the rest: Roll your 401k over into an IRA. 

What is a 401k Rollover?

Despite how it may sound, a “401k rollover” is just a term used to describe moving your money from your old 401k plan into a different retirement plan. The new plan could be a new IRA, an existing IRA, or even another 401k plan.

Since the majority of the time, this other fund is a newly created IRA, you’ll often hear it referred to as a “rollover IRA”. Generally speaking, most rollover IRAs are exactly the same thing as a traditional IRA. The only difference was that you contributed your entire 401k balance instead of just the usual amount of $6,000 per year (as of 2020).

Which Type of IRA – Traditional or Roth?

Because taxes work differently with traditional and Roth style plans, you’ll need to be careful about which type of IRA you open when making a 401k rollover.

The safest way to do this is to always match up the type of your 401k plan with the type of your IRA. For example, if you plan to roll over the money from your traditional 401k, then you’d want to move it into a traditional IRA. By doing it in this way, both accounts have the same tax-deferred rules, and therefore you won’t owe anything to the IRS.

You can always mix account types such as moving money from your traditional 401k to a Roth IRA. However, know that it will mean that you’ll have to pay taxes on this rollover (since Roth style plans are taxed upfront).

For example, if you’ve got $100,000 to roll over and you’re in the 28% tax bracket, this could mean you’ll owe approximately $28,000 in taxes for the year! Unless you’re truly prepared to go through with this arrangement, it’s better just to keep your account types the same.

Why You Should Roll Over Your 401k

For one thing, IRAs are generally cheaper than 401k plans. You may not realize it, but on top of the expenses that you generally pay for mutual funds, your 401k plan may also be charging you an administrative fee as well for maintaining the plan. By contrast, with IRAs, there are no administrative plan fees.

If the investment choices your 401k plan offers feels limited, then an IRA can really open your doors to other options. You can pick from mutual funds, ETFs (exchange-traded funds), stocks, bonds, etc. You’re also allowed to invest in precious metals and real estate if you’re so inclined.

If you’d prefer not to pick out your own funds and would rather have someone else manage them for you, then that could be an option too. There are dozens of different robo-advisors on the market that will gladly take care of your IRA for you.

And then there’s my favorite benefit of all: If you have any dreams of retiring early, then you probably already know that the IRS has a 10 percent penalty you’ll have to pay if you try to make any withdraws from your 401k before age 59-1/2.

However, with an IRA, you have the option to access this money using something called Rule 72t. Under this little-known rule, you can elect to make a series of SEPPs (substantially equal periodic payments) without having to pay the 10 percent penalty. This is a pretty useful trick for early retirees!

How to Do a 401k Rollover

Rolling over your savings from a 401k into an IRA is a relatively straight-forward process. There are two main ways to complete one.

Direct Rollovers

The easiest way to do this is to contact the financial institution where you plan to transfer the money to. If you already have an account and an IRA, then you’re already halfway there. If you don’t, then the institution will probably want you to first create an account and then open an IRA.

From there, you’ll do what’s called a direct rollover. This is where the money from your 401k transfers directly (electronically) over to your new financial provider’s IRA. You’ll have to fill out a few forms to authorize the transfer. You may also have to contact your former employer’s 401k plan administrator to complete the process.

Before the money transfers, your IRA provider will also need to know what types of funds you’d like to invest in. Do some work ahead of time researching your options and pick out which ones you’d like. Remember you can also use a robo-advisor if you’d rather not do this yourself.

Indirect Rollovers

Another way to complete the transfer is to perform what’s called an indirect rollover. This is where you manually pull the money out of your old plan (usually be check) and then send it to your IRA provider.

While many people have performed indirect rollovers successfully, know that there are some risks. For starters, if you don’t perform the rollover within 60 days, the withdrawal may be subject to taxes and penalties from the IRS. Also, if you lose the check, then you may risk losing your savings.

One bright spot with an indirect rollover is that it can be useful if you need a very, very short-term loan. However, at the risk of owing taxes and penalties, I’d recommend using the direct rollover method whenever possible.

Put Your Money to Work

Just because you left your job doesn’t mean you have to leave your money behind. The best thing you can do with your 401k is to roll it over into an IRA. Just be careful to make sure you won’t do anything to trigger any unwanted taxes or penalties, and you’ll be able to put your money to work growing for decades to come.

Contributor’s opinions are their own. Always do your own due diligence before investing.

Keep Reading:

Get Richer Sleeping eBook & Financial education emails

Written by DJ Whiteside

DJ writes about retirement and credit cards. He loves looking for new ways to optimize savings, build wealth, and sharing what he learns with others.

More From Finance