What is a 401k Rollover?
A 401k rollover occurs when you change jobs or retire and then elect to transfer or "rollover" your 401k into a new IRA. This process of transferring a 401k with a previous employer into an IRA is referred to as a “401k Rollover”, “Rollover IRA” or “IRA Rollover.”
The assets in your 401k can be transferred from your 401k directly to an IRA via a trustee-to-trustee transfer. A direct rollover from a 401k to an IRA is made tax-free and there is no tax liability. There is no limitation on the dollar amount you can rollover from your previous employer's retirement plan.
When I change jobs or retire, what are my options for my 401k?
When you leave your employer, you will need to decide what do to with the money you have accumulated in your employer's 401k. For some investors this may represent a sizeable investment. As a result, it is crucial to make an informed decision.
There are several options available to you:
- Take the money out in Cash
For most investors this is the worst option. Taking a distribution in cash has very serious tax consequences. Your previous employer is required to withhold 20% for federal taxes. The cash that you receive will be taxed as ordinary income. The 20% that is withheld will be used to pay the taxes you owe for your federal taxes. However, depending on your tax bracket you may owe more than the 20% that was withheld when you do your taxes for that year. In addition, you are likely to be penalized 10% if you are younger than age 59 1/2. As you can see, this can be a major setback towards saving for your retirement.
- Leave the money with your old employer's retirement plan
For many investors who are saving for their retirement, this may be a better decision than Option 1 since you will not be penalized or taxed, however there are some disadvantages. Many investors find it difficult to manage and organize their retirement accounts when they have several retirement plans at previous employers. As a result, investment performance can suffer if retirement accounts are not diversified properly. An even more important issue is most employer's retirement plans have a fairly limited number of mutual funds choices (usually only 10-15).
- Transfer the money into your new employer's retirement plan
Most employers allow you to do a transfer into their retirement plan. Compared to Option 2 this avoids the potential problem of multiple retirement accounts at different employers and the difficulties of managing your investments and organizing them properly. As in Option 2 the same important issue still applies, as most employer sponsored retirement plans have a fairly limited number of mutual fund choices (usually 10-15).
- Transfer the money into a Rollover IRA
For many investors a 401k rollover into an IRA is the best option for the money they have saved in their previous employer's retirement plan. Compared to Options 1-3 you have several advantages: increased control, greater organization, improved investment flexibility and investment advice.
Advantages of a 401k Rollover to IRA
- Investment Flexibility
- Investment Advice
Learn more about the advantages of a 401k rollover.