Do You Lose Money When You Rollover a 401k?

A 401(k) rollover moves funds from an employer-sponsored retirement plan into another qualified retirement account, such as an Individual Retirement Account (IRA) or a new employer’s 401(k). This article guides readers through 401(k) rollovers, highlighting potential financial pitfalls and outlining steps to protect retirement savings.

Tax Considerations for Rollovers

The method chosen for a 401(k) rollover impacts its tax implications. A direct rollover, or trustee-to-trustee transfer, moves funds directly from the old plan administrator to the new account custodian. This method avoids immediate tax withholding and penalties, maintaining the tax-deferred status of your retirement savings. There are no immediate tax implications when completing a direct rollover from a 401(k) to an IRA.

An indirect rollover distributes funds directly to the account holder. The individual has a 60-day period to deposit the entire amount into a new qualified retirement account. If funds are not redeposited within this deadline, the distribution becomes taxable as ordinary income. This can result in a significant reduction of retirement savings due to income tax liabilities.

If the account holder is under age 59½ and fails to meet the 60-day rule, the distribution may also be subject to an additional 10% early withdrawal penalty, on top of ordinary income tax. This penalty can substantially diminish retirement savings.

Indirect rollovers from a 401(k) include mandatory 20% federal income tax withholding. Even if the individual intends to complete the rollover within 60 days, the plan administrator must withhold 20% for taxes. To roll over the full original amount and avoid tax consequences, the individual must deposit 100% of the distribution into the new account, contributing the 20% from other personal funds.

The withheld 20% is credited back when filing the federal income tax return. However, these funds are tied up until the tax refund is processed. Failure to replace the withheld amount from other sources, leading to only 80% being rolled over, results in the 20% portion being treated as a taxable distribution and potentially subject to the 10% early withdrawal penalty. The once-per-year rule applies to indirect rollovers across all IRAs.

Understanding Fees and Investment Choices

Various fees can be associated with a 401(k) rollover. Some old 401(k) plans may charge a closeout or administrative fee to process the transfer of funds. These fees vary by plan.

Once funds are rolled into a new account, such as an IRA, new fees may apply. Account maintenance or custodial fees are sometimes charged by IRA providers for holding the account. These annual fees vary, though some providers waive them.

Investment-related fees can significantly impact the long-term value of a retirement account. Expense ratios, annual fees charged by mutual funds or exchange-traded funds (ETFs) for management, administration, and marketing, are deducted from the fund’s returns. A 1% expense ratio on a $10,000 investment means $100 in annual fees, which can substantially reduce returns over time. Actively managed funds often have higher expense ratios than index funds.

Trading fees or commissions may also apply when buying or selling investments within the new account. Advisory fees, if a financial advisor is used, are charged as a percentage of assets under management. Even small fees can compound over decades, eroding the potential growth of retirement savings.

During a rollover, especially an indirect one where funds are out of the market, there is a risk of missing potential investment gains or being exposed to market downturns. This can affect the account’s value. Consolidating multiple retirement accounts into a single IRA can simplify financial management and potentially reduce overall administrative fees.

Executing Your 401(k) Rollover Safely

To ensure a 401(k) rollover proceeds without financial loss, follow a structured process. Contact the administrator of your old 401(k) plan. They will provide the necessary forms and instructions for initiating a rollover.

When communicating with the plan administrator, request a direct rollover, also known as a trustee-to-trustee transfer. This directs funds to be sent directly from your old plan to your new retirement account custodian, bypassing your personal possession. A direct rollover avoids the mandatory 20% tax withholding and the 60-day rule, reducing the risk of tax penalties and complications.

Provide the old plan administrator with the exact account details of your new retirement account. This includes the name of the new custodian, the new account number, and the mailing address or wire transfer instructions for the new institution. Ensure any check issued is made payable directly to the new custodian “for the benefit of” you, rather than to you personally.

After initiating the rollover, monitor the transfer process. Confirm with your old plan administrator that funds have been disbursed and obtain a tracking number if available. Verify with your new account custodian that funds have been received and deposited into your account. Once funds arrive, ensure they are invested according to your instructions, as uninvested cash will not generate returns.

Maintain records of all communications and transactions throughout the rollover. Keep copies of completed forms, correspondence, and notes from phone calls, including dates and names of representatives. Retain confirmation statements from both the old and new accounts showing the transfer of funds. This documentation serves as a safeguard for tax purposes and to resolve any discrepancies.

A direct rollover typically takes a few weeks to complete. By following these procedural steps, you can ensure a smooth, tax-compliant, and fee-aware transfer of your retirement savings.