How to Roll Over Your 401k When You Change Jobs

When you leave an employer, your 401(k) retirement savings plan requires a decision. A 401(k) rollover moves these assets from your former employer’s plan to another qualified retirement account. This process allows your retirement savings to continue growing on a tax-deferred basis without incurring immediate taxes or penalties, and helps consolidate your accounts.

This decision typically involves considering where the funds will be transferred and the method used for the transfer.

Your Rollover Options

When transitioning jobs, individuals have two primary destinations for their previous employer’s 401(k) funds: a new employer’s 401(k) plan or an Individual Retirement Account (IRA).

Rolling your 401(k) into your new employer’s 401(k) plan allows your retirement savings to remain within a qualified employer-sponsored plan. This option may be suitable if your new employer’s plan offers investment options that align with your risk tolerance and financial objectives. Employer-sponsored plans often benefit from strong creditor protection under the Employee Retirement Income Security Act (ERISA), safeguarding assets from creditors in most bankruptcy scenarios. However, the investment choices within an employer’s 401(k) plan are limited to the options curated by the plan administrator, which might not always include every desired investment vehicle.

Alternatively, rolling your 401(k) into an IRA provides a broader array of investment choices, including individual stocks, bonds, mutual funds, and exchange-traded funds, offering greater flexibility to customize your portfolio. IRAs offer more control over investment decisions compared to employer-sponsored plans. While IRAs also offer creditor protection, the extent of this protection can vary by state law, and it may not be as comprehensive as the federal ERISA protections afforded to 401(k) plans.

Withdrawal rules also differ between these account types. Funds in a 401(k) are subject to a 10% early withdrawal penalty for distributions taken before age 59½, though exceptions apply. IRA distributions are also subject to the 10% early withdrawal penalty before age 59½, but IRAs have additional exceptions, such as for higher education expenses or first-time home purchases.

Understanding Rollover Mechanics

Once you have determined the optimal destination for your 401(k) funds, understanding the mechanics of the transfer process is the next step. There are two primary methods for executing a rollover: a direct rollover and an indirect rollover.

A direct rollover involves the funds being transferred directly from your old 401(k) plan administrator to the new account, whether it’s a new 401(k) or an IRA custodian. In this method, the money never passes through your hands. This trustee-to-trustee transfer is the most straightforward method because it avoids any mandatory tax withholding. The entire amount is transferred, maintaining its tax-deferred status without immediate tax consequences.

An indirect rollover, however, involves the plan administrator issuing a check for your 401(k) balance directly to you. When this occurs, the plan administrator is required by law to withhold 20% of the distribution for federal income taxes. You then have 60 days from the date you receive the funds to deposit the entire amount, including the 20% that was withheld, into a new qualified retirement account. If you do not roll over the full amount, including the withheld portion, the unrolled amount will be considered a taxable distribution and may be subject to income tax and a 10% early withdrawal penalty if you are under age 59½. You would need to use other funds to make up the 20% that was withheld to complete the full rollover within the 60-day window.

The 60-day rule for indirect rollovers is a strict deadline. If the funds are not deposited into a new qualified retirement account within this period, the entire distribution becomes fully taxable as ordinary income. This can lead to a substantial tax liability and potential penalties, making the direct rollover a less risky option for most individuals.

Steps for a Successful Rollover

After deciding on the destination for your 401(k) funds and understanding the transfer mechanics, the next stage involves executing the rollover. The first step involves contacting the administrator of your former employer’s 401(k) plan. You will need to inform them of your intention to roll over your funds and request the necessary distribution forms. During this initial contact, inquire about their specific rollover procedures and any required documentation they may need from you or the receiving institution.

Simultaneously, contact the administrator of your new 401(k) plan, if applicable, or the custodian of the IRA you intend to use for the rollover. You will need to open a new account or designate an existing one to receive the rollover funds. Request their rollover instructions and any forms they require to accept the incoming transfer. They may also need information about your old 401(k) plan to facilitate a direct transfer.

Once you have gathered all the necessary forms from both the sending and receiving institutions, complete them accurately and thoroughly. These forms will ask for details such as your personal information, the account number of your old 401(k), and the account number of the new retirement account. Pay close attention to sections that specify the type of rollover (direct or indirect) to ensure your chosen method is properly initiated.

After submitting the completed forms, the plan administrators will begin processing your request. For a direct rollover, the funds will be electronically transferred or a check will be issued directly to the new account custodian, which can take approximately two to six weeks. If you opted for an indirect rollover, you will receive a check made out to you, with 20% of the funds withheld for taxes. Remember, you have 60 calendar days from the date you receive this check to deposit the full amount into your new retirement account to avoid taxes and penalties.

It is advisable to track the progress of your rollover regularly by contacting both the sending and receiving institutions. Confirm that the funds have been successfully transferred and properly allocated to your new account. Once the funds are confirmed in the new account, retain all documentation related to the rollover for your records.

For tax purposes, you will receive Form 1099-R from your old 401(k) plan administrator, which reports the distribution amount. If you rolled into an IRA, you will also receive Form 5498 from the IRA custodian, indicating the amount contributed to the IRA. This documentation is important for accurate tax reporting.