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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 401(k)? 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.
Rolling over a 401(k) plan into an IRA gives the investor a wider range of options and securities than a traditional 401(k). In addition, as long as the money has been held in the 401(k) for at least 5 years, there are no fees or penalties for rolling it over.
You could also move the money into your new employer’s 401(k) 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, the best option is to roll your 401(k) over into an IRA.
What Is A 401(k) Rollover To IRA?
Despite how it may sound, a 401(k) rollover is just a term used to describe moving your money from your old 401(k) plan into a different retirement plan.
The new plan could be a new IRA, an existing IRA, or even another 401(k) 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 the same thing as a traditional IRA.
The only difference was that you contributed your entire 401(k) balance instead of just the usual amount of $6,000 per year (as of 2022).
Why You Should Consider A 401(k) Rollover To IRA
For one thing, IRAs are generally cheaper than 401(k) plans.
You may not realize it, but on top of the expenses that you generally pay for mutual funds, your 401(k) 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 401(k) plan offers feel limited, then an IRA can 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 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% penalty you’ll have to pay if you try to make any withdraws from your 401(k) 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% penalty. This is a pretty useful trick for early retirees!
Should You Move Your 401(k) To Roth IRA Or Traditional IRA?
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 401(k) rollover.
The safest way to do this is to always match up the type of your 401(k) plan with the type of your IRA.
For example, if you plan to roll over the money from your traditional 401(k), 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 401(k) 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.
How To Rollover Your 401(k) Into An IRA
Rolling over your savings from a 401(k) into an IRA is a relatively straightforward process. There are two main ways how to do a 401(k) rollover
1. Direct Rollovers
The easiest way to do this is to contact the financial institution to which you plan to transfer the money.
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 401(k) 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 401(k) 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.
2. 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 With A 401(k) To IRA Rollover
Leaving your job doesn’t mean you have to leave your money behind.
The best thing you can do with your 401(k) 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.