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Table of Contents

401(k) Rollovers: The Complete Guide

Rolling over a 401(k) to an IRA can give you more options and lower fees

Rolling over your 401(k) plan to an IRA when you switch jobs can provide you with more investment options, lower investment fees, and greater control of your money. If these features appeal to you, here’s what to know about making the switch.

Key Takeaways

  • Choosing to roll your 401(k) plan to an IRA when you switch jobs can provide you with more investment options, lower investment fees, and more control over your money.
  • When you roll over your 401(k) you can choose either a traditional IRA or a Roth IRA, both with their own benefits and drawbacks.
  • If you want to roll your 401(k) money into a Roth IRA, you’ll have to do a Roth conversion. You'll have a tax bill to pay when you switch over.
  • Rolling your 401(k) money into a traditional IRA does not require a conversion process or an income tax payment.
  • A traditional IRA and a Roth IRA both have the same contribution limits: $6,000 in 2022 and $6,500 in 2023, plus an additional $1,000 if you are aged 50 and over.

How to Get Started

Getting started with a 401(k) rollover is somewhat straight-forward, as the process entails the following these four steps:

1. Choose Between a Roth and a Traditional IRA

You can roll your 401(k) into either a Roth or a traditional individual retirement account (IRA). Both plans have the same annual contribution limits: $6,000 for 2022 and $6,500 for 2023, plus a catch-up contribution limit of $1,000 for employees aged 50 or older. The table below shows the major differences between the two types of IRAs.

Which Type of IRA Is Best for Your Rollover?
Roth Traditional
Contribute at any age Contribute at any age*
Contributions phase out above certain income levels Contribute no matter how high your income
Pay income tax on the 401(k) balance you’re rolling over now No income tax now
No income tax on qualified withdrawals Pay income tax on qualified withdrawals
Conversion amount must remain in account for five years Five-year rule does not apply
Tax- and penalty-free withdrawals for any reason after five years Tax- and penalty-free withdrawals anytime but only under certain conditions 
No required minimum distributions Required minimum distributions start at age 73**

The rule that you could not contribute past age 70½ was repealed by the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The SECURE Act of 2019 changed the age at which you must take required minimum distributions (RMDs), from 70½ to age 72, which was raised again to age 73 beginning in 2023 and age 75 beginning in 2033.

If you want to roll your 401(k) money into a Roth IRA, you’ll have to do a Roth conversion. Contributions to a 401(k) are untaxed, while Roth IRA contributions are taxed. So you’ll have a tax bill to pay when you switch over.

Rolling your 401(k) money into a traditional IRA does not require a conversion process or an income tax payment.

2. Open an IRA Account

If you already have an IRA account, you can skip this step. If not, or if you want to open a different type of IRA, use a different provider, or avoid commingling funds, here’s what you need to do.

Choose the provider (brokerage) where you want to open your new Roth or traditional IRA and make sure it accepts 401(k) rollovers (it probably does). Open an account online or by phone. 

If you prefer investments from a certain provider such as Fidelity, Vanguard, or Schwab mutual funds, you might want to open your account with one of those firms to get commission-free trades on those products. If you make lots of trades, look for a brokerage with low commissions. If you want a hands-off approach, open your account with a robo-advisor.

3. Request a Direct Rollover From Your 401(k) Plan Administrator

There’s more than one way to do a rollover, but a direct rollover is by far the simplest and will help you avoid mistakes. Your 401(k) plan administrator will send a check for your account balance directly to your IRA provider, who will deposit the money in your IRA. You won’t have to worry about penalties or unintended tax bills. Plus, you’ll only have to pay ordinary income taxes if you’re doing a Roth conversion.

An indirect rollover is defined as a transfer between tax-deferred accounts in which the owner actually receives the funds and must personally deposit the proceeds into the new account. If the person takes possession of this type of distribution, they often have 60 days to contribute the funds to a new account before being assessed income taxes or penalties. To avoid any risk in this situation, it's often heavily advised to pursue direct rollovers when possible.

4. Decide How to Invest Your Money

Letting your money languish in a money market account means it probably won’t grow as much as you need it to if you want to retire. It may even lose money over time because of inflation. On the other hand, this risk-adverse strategy has a higher chance of preserving your retirement balance, an important distinction for those close to retirement age.

For investors with a longer investing horizon, a common option is to invest in a diversified mix of stocks and bonds through a low-cost S&P 500 index fund and a low-cost bond fund. Other people prefer to do more research and choose individual stocks and bonds instead of investing in funds. 

To decide what to invest in, consider your personal risk profile and risk appetite. This includes your willingness to pursue portfolio growth at the expense of incurring investment losses.

How to Choose an IRA Provider

You almost can’t go wrong these days when choosing a provider. Pick a well-known company with a good reputation and you’ll have access to a huge variety of investments and low fees. These providers will often have robust systems for you to interact with via browser websites or mobile applications.

It will be up to you to make the most of the situation by choosing the investments that likely would perform well. Some providers may offer roboadvising services, while others may have representatives to help. There is no harm at all in speaking to several providers, getting a feel for their offerings, seeing if you like their trading platforms, and selecting your favorite from the group.

Best for Hands-On Investors

Opening your rollover account with a traditional brokerage will allow you to choose your own portfolio of diversified, low-cost investments and decide how much of your money to allocate to each. You’ll be responsible for your own portfolio rebalancing, and when you make contributions, you’ll need to allocate those to new or existing investments.

When it comes to choosing a brokerage, you have dozens of options. Some of the most popular and well-liked include Fidelity, Vanguard, Schwab, TD Ameritrade, and E*TRADE, but everyone has preferences. Some people care more about having an easy-to-use interface, while others may care more about account minimums or fees.

Best for Hands-Off Investors

If you don’t have the first clue about how to assemble and manage your own portfolio, that’s fine—you don’t need to know these things, and making it happen doesn't have to cost much. Nor do you need to be rich.

It used to be that the only way to get around managing your own money was to hire a financial advisor, something that was out of reach for most people because they didn’t have enough investable assets.

However, with the emergence of robo-advisors, such as Betterment, SigFig, WealthSimple, and Wealthfront, almost anyone can attain a low-cost, diversified, and professionally managed portfolio.

Opening your rollover account with a robo-advisor means an algorithm will manage your portfolio for you after you provide your risk tolerance and your intended retirement age. You can be a hands-off investor even if you don’t choose a robo-advisor. You could go with a target-date fund or a couple of index funds.

Some companies have both hands-on and hands-off options or a hybrid option. Check out Vanguard, Schwab, Motif, and E*Trade, for example.

Pay Attention to Fees

Fees impact your returns. The lower your fees, the better your returns, all else being equal. Higher fees are not correlated with better service or better performance.

Keep the long view in mind when evaluating fees. Paying a commission to buy a stock that you hold long-term can actually be cheaper than paying a mutual fund’s expenses every year.

Some providers will pay you a bonus for opening your rollover IRA with them. A bonus should not be your sole reason for choosing a provider, but it is a nice perk and it can help offset fees. Keep in mind, the bonus may be taxable income.

Can You Roll Over a 401(k) Into an IRA Without a Penalty?

Yes, you can roll over a 401(k) into an IRA without a penalty; however, you must complete the rollover within 60 days of withdrawing your 401(k) balance, otherwise, you will be charged a 10% early withdrawal penalty.

What Are the Tax Consequences of Rolling a 401(k) Into an IRA?

If you roll over your 401(k) into a traditional IRA, your funds remain tax-deferred as both plans are pre-tax, and you will not have to pay any taxes during the process. If you roll over into a Roth IRA, which is an after-tax account, you will have to pay taxes on the funds you roll over.

What Are the Contribution Limits for IRAs?

The contribution limits for a traditional IRA and a Roth IRA in 2022 is $6,000, and the 2023 contribution limit is $6,500. If you are aged 50 and over, you can contribute an additional $1,000.

The Bottom Line

You don’t have to roll over your 401(k) to an IRA when you change jobs. You can cash out your balance, but we don’t recommend it because you’ll pay taxes and penalties and lose the progress you’ve made toward retirement. You can also roll over the money to an eligible retirement plan offered by your new employer, such as another 401(k). Some employers may even allow you to leave your 401(k) where it is.

Many people who change jobs do choose to roll their 401(k) into a traditional or Roth IRA because of the potential for lower investment fees, more investment options, and more control over their money. If you go this route, you’ll need to make some key decisions about what kind of account to open, how hands-on you want to be, and which brokerage will handle your account.

Article Sources
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