Here’s How to Roll Over a 401(K) Into an IRA

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One of the most common benefits of working for an employer is the company-sponsored 401(k) plan. But what happens to that money if you quit your job?

If you’ve jumped orbit a lot, chances are you already have a few 401(k)s floating around.

When you leave a company, you have several options for what to do with your 401(k) subscription. Because most 401(k) plans are set up for employees to contribute pre-tax dollars and then not withdraw money until they are at least 59 ½ years old, whatever you do, you should try to avoid early withdrawal fees.

Here’s how to transfer a 401(k) to an IRA and how to decide which option is right for you.

Keep your current 401(k) subscription

First, whatever you do, don’t withdraw the money. This means you have to cash out your 401(k) and deposit that amount into your checking account and use it for other expenses. This is a bad idea. If you do, you’ll be fined by the IRS, and the money will count as income that increases your federal taxes for the year. While it may be tempting, you can try other options instead.

One of the easiest things you can do instead is leave your current 401(k) balance where it is, even if you can’t make additional contributions.

This option may be appropriate for someone who is happy with the benefits and performance of their current 401(k) plan and who has no other retirement account to move the balance into.

But this option may not be the best because in a decade or two you may have a handful of 401(k) plans with previous employers, making them easy to lose track of and difficult to manage.

Also, not every employer will allow you to keep your 401(k) open after you leave. Some may have a minimum balance requirement or require you to relocate your retirement funds into a new account with the same investment manager.

It may also depend on the size of your employer. Larger companies “don’t mind having additional participants in their plan,” said Mark Deering, a CFP and Senior Executive Vice President at Southwestern Investment Group† “Smaller plans will often try to coerce participants as soon as they leave the service to avoid having their plan checked or incurring increased administrative costs.”

Rolling over your 401(k) to an IRA

Another option when you leave a job is to roll your 401(k) balance into an IRA or individual retirement account. An IRA is also a tax-advantaged retirement account, but rather than being sponsored by an employer, it is self-directed.

One of the main reasons someone might choose to roll their 401(k) into an IRA is the wider variety of investments available, says Lazetta Rainey Braxton, a certified financial planner and co-founder of the financial planning firm. 2050 Wealth Partners

“With the rollover IRA, you have more options in terms of what you can invest in, whereas with an employer 401(k) it’s the employer’s responsibility to figure out what the investment menu is,” Braxton says.

If you already have an IRA, you can often deposit your 401(k) balance into your existing account. If you don’t already have an IRA, you’ll need to open one before you can start the transfer.

Once you have an IRA, contact your former 401(k) plan administrator and let them know that you want to transfer the balance. They may require paperwork completed by you or your IRA provider.

The rollover will occur in one of two ways:

The 401(k) administrator may be able to send the money directly to the IRA provider, who will then deposit it into your account. Or, you may receive a check with your 401(k) balance, which you must then deposit into your IRA. You must do this within 60 days, otherwise the check will be considered a withdrawal, which would result in an early withdrawal penalty and income tax. Many brokers have easy-to-use interfaces that allow this process to be done digitally by simply taking a picture of the check and depositing it into the account.

Rolling Over Your 401(k) to a Traditional IRA vs. a Roth IRA

You have the option of rolling your 401(k) into a traditional IRA or a Roth IRA. One isn’t better than the other, and ultimately it’s up to you and your investment goals.

There are a few things to worry about, though, and the big difference is this: Roth IRAs require after-tax contributions. If you roll over money from a traditional 401(k), you didn’t pay tax on that money when it came out of your paycheck before you got your paycheck. As a result, when you roll over from your traditional 401(k) balance to a Roth IRA, you must pay income tax on the entire balance in the year you make the rollover. This can mean thousands of dollars in taxes. So just be careful with this.

However, it’s easier to roll a traditional 401(k) into a traditional IRA because both contain pre-tax dollars. You don’t have to worry about causing a chargeable event.

Similarly, a Roth 401(k) and Roth IRA are both funded with after-tax dollars, which means that merging a tax requires no tax payment.

Paying income taxes by rolling a traditional 401(k) into a Roth IRA isn’t necessarily a reason not to: Roth IRAs can be a powerful tool for saving for retirement, and some investors may give them the prefer to pay the tax bill now for the benefit of withdrawing tax-free money during retirement.

But whatever decision you make, it’s important that you understand the implications and have your budget ready.

Switching to a new 401(k)

If you’re moving to another employer that also offers a 401(k), consider transferring your balance to the new company. The advantage of this option is its simplicity: you only need to maintain one retirement account instead of multiple accounts.

In most cases, this type of rollover can be as simple as filling out a few online forms, and the companies that manage your 401(k)s can usually handle it themselves.

“This process is usually initiated by paperwork from the receiving 401(k) plan,” Deering says. For example, if my 401(k) was with T. Rowe Price and I wanted to pass an older 401(k) plan I had with Fidelity, I would contact T. Rowe Price to get their rollover papers and submit it to Trouw to distribute the check.”

Cash out your 401(k)

When you leave a job it can be tempting to cash in the 401(k), but this should only be done in extreme circumstances. Not only are you robbing your future self of your retirement savings, but you are also losing a significant portion of its value.

When you cash out your 401(k), you will have to pay income tax on it, as well as an additional 10% penalty for early withdrawal. You can easily lose 30% of the account balance in taxes and fees.

In addition, cashing out your 401(k) now reduces the amount of money you will have available in retirement. As long as that money isn’t on the market, it won’t grow.

Be careful to convince yourself that you can replace it later. Because of compound interest, time makes the difference. The more time your money invests, the more chance it has of growing into a comfortable retirement nest.

“This is rarely the best thing to do,” Deering says. “It takes a lot of effort, time, and resources to save for retirement, and every dollar helps.”

How to decide which rollover is right for you?

When you leave an employer, you must decide whether to leave your 401(k) in place, roll it into an IRA, or roll it into a new 401(k).

First, consider the fees each plan charges. If you find that the fees at your previous company are higher than what you would pay at your new company or in an IRA, then it makes sense to roll over your balance. Moving the money into an IRA can be an effective way to cut costs – some online brokers offer 0% expense ratios on index funds.

Pro tip

When deciding what to do with your 401(k) balance when you leave your job, consider factors such as your investment performance to date, the fees your plan charges, and the variety of investment options available to you. are available. Compare those factors to your new employer’s 401(k) or an IRA to decide which plan is more attractive.

Also take a look at the investment opportunities available to you. 401(k) plans usually come with a select list of investments from which to choose, while an IRA has many more options. Some investors prefer to have more options, while others may find it overwhelming.

“You need to feel comfortable making those selections or working with a financial planner or advisor who can also guide you,” Braxton says.

That said, investors looking to convert their 401(k) into an IRA and not comfortable choosing their own investments may also want to consider a robo-advisor, who will choose investments on your behalf based on your time horizon and financial goals. Robo-advisors are great ways for all investors to take control of their investments.

What to do with employee stock?

If you have employee shares through your former employer, you also need to decide what to do with those shares. In the case of stocks you already own, Deering advises that it may make sense to sell those shares. In any case, make sure the stocks don’t make up a disproportionate percentage of your portfolio, as can sometimes happen with employee stocks.

According to Deering, the most important consideration is whether there’s anything stopping you from selling the stock. In some cases, there may be lock-out periods that prevent you from selling your shares for a period of time. And if you’ve owned the stock for less than a year, it makes sense to hold them until the one-year period when you qualify for long-term tax treatment.

If you have any remaining stock options, they will likely expire within three months of leaving the company. Whether you choose to exercise these should depend on the current stock price compared to the price at which your options allow you to buy them, as well as how much of the company’s stock you already have in your portfolio.

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