How to Roll Over Your 401k to a New Employer

When individuals change jobs, they often encounter a decision regarding their previous employer’s retirement savings plan. A 401(k) rollover involves moving funds from an old 401(k) account into another qualified retirement account. This process allows individuals to consolidate their retirement savings and maintain the tax-deferred status of their investments. Understanding the options and procedures involved helps ensure a smooth transition of these important financial assets.

Choices for Your Old 401(k)

Upon leaving an employer, individuals typically have several options for managing the funds held in their former 401(k) plan. One choice is to leave the money in the old employer’s plan, provided the plan administrator allows it and the account balance meets any minimum requirements.

Another alternative is to cash out the funds, which involves taking a direct distribution of the money. However, this action generally triggers immediate income taxes on the distributed amount, and if the individual is under age 59½, an additional 10% early withdrawal penalty may apply. Cashing out can significantly reduce the total amount available for retirement savings due to these tax consequences.

The third common option is to roll over the funds into a new qualified retirement account. This typically involves transferring the money to an Individual Retirement Account (IRA) or to the new employer’s 401(k) plan, if permitted. A rollover allows the funds to continue growing on a tax-deferred basis, preserving their retirement savings potential without incurring immediate taxes or penalties.

How Rollovers Work

Two primary methods exist for executing a 401(k) rollover: a direct rollover and an indirect rollover. In a direct rollover, the funds are transferred directly from the old 401(k) plan administrator to the new retirement account custodian or plan administrator. The money never passes through the hands of the individual, ensuring the tax-deferred status is maintained seamlessly.

An indirect rollover, conversely, involves the funds being distributed directly to the individual. The individual then has 60 days from the date of receipt to deposit the funds into a new qualified retirement account to avoid taxes and penalties. If the funds are not redeposited within this 60-day window, the entire distribution becomes taxable income, and an early withdrawal penalty may apply if the individual is under age 59½.

When an indirect rollover occurs, the 401(k) plan administrator is required to withhold 20% of the distribution for federal income taxes. This mandatory withholding applies even if the individual intends to roll over the full amount. To complete a full rollover, the individual must replace the 20% that was withheld with other funds from their own resources. The withheld amount can then be recovered when filing federal income taxes for the year.

Gathering Information and Making Decisions

Before initiating a 401(k) rollover, gathering specific information and making informed decisions is important. Begin by identifying the previous 401(k) plan administrator and obtaining their contact information. Understanding the specific rules of the old 401(k) plan regarding rollovers, including any required forms or procedures, is also necessary.

A significant decision involves choosing the destination for the rollover funds: either your new employer’s 401(k) plan or an Individual Retirement Account (IRA). Factors to consider when making this choice include the investment options available in each account; some 401(k) plans may have a more limited selection compared to the broader range of investments typically found in an IRA. Fees associated with each account also warrant careful comparison.

Other considerations include loan provisions, which are generally available only in 401(k) plans, allowing participants to borrow against their vested balance. Creditor protection for 401(k) plans is generally stronger under federal law, offering a higher degree of protection from creditors compared to IRAs. Required minimum distributions (RMDs) typically begin at age 73 for both account types.

Finally, consider the tax treatment of the accounts. Rolling over pre-tax 401(k) funds to a traditional IRA or a new traditional 401(k) maintains their tax-deferred status. Converting pre-tax funds to a Roth IRA, however, makes the entire converted amount immediately taxable as ordinary income.

Steps to Initiate and Complete a Rollover

Once all necessary information has been gathered and a decision on the destination account has been made, the next step is to initiate the rollover process. Contact the previous 401(k) plan administrator to formally request the rollover, completing and submitting the specific rollover forms. Ensure all sections are accurately filled out, providing details for the receiving institution.

Specify whether you prefer a direct rollover to the new plan administrator or IRA custodian. If you opt for a direct rollover, the funds will be transferred electronically or via a check made payable directly to the new institution for the benefit of your account.

For an indirect rollover, where a check is issued to you, deposit the full amount into a new qualified retirement account within 60 calendar days of receiving the distribution. To complete a full rollover and avoid any taxable event, you must contribute the full original amount, including the 20% that was withheld, from your other personal funds.

After the transfer is initiated, monitor the process. For direct rollovers, confirm with the new plan administrator or IRA custodian that the funds have been successfully received. For indirect rollovers, verify that your deposit was processed correctly by the new institution. Keeping records of all communications, forms, and confirmations is advisable.

Key Tax Rules for Rollovers

Properly executed 401(k) rollovers are generally non-taxable events, allowing your retirement savings to continue growing without immediate taxation. However, specific rules must be followed to maintain this tax-advantaged status.

For indirect rollovers, the mandatory 20% federal income tax withholding on the distribution is a key tax consideration. This withholding is required even if you intend to roll over the entire amount. The IRS requires reporting of 401(k) distributions, including rollovers, on Form 1099-R, “Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.” This form indicates the gross distribution and any federal income tax withheld, which you will use when filing your federal income tax return to account for the rollover and claim credit for the withheld amount.

Rolling over pre-tax 401(k) funds into a traditional IRA or a new traditional 401(k) maintains their tax-deferred status. If you choose to convert pre-tax 401(k) funds to a Roth IRA, the entire amount converted becomes taxable income in the year of conversion.