How to Transfer Your 401(k) From a Previous Employer

A 401(k) is a retirement savings plan sponsored by an employer, allowing employees to save and invest a portion of their paycheck before taxes are withheld. These contributions, and any investment earnings, can grow tax-deferred until retirement, when withdrawals are taxed as ordinary income. When an individual leaves an employer, their existing 401(k) account requires a decision regarding its future management. Understanding the available choices is important for preserving accumulated retirement savings and continuing their tax-advantaged growth.

Exploring Your 401(k) Transfer Options

When transitioning from one employer to another, individuals have several distinct paths to consider for their previous 401(k) plan. Each option carries specific implications regarding tax treatment, access to funds, and investment control.

One option is to leave the funds in the former employer’s 401(k) plan. Many plans permit this, especially if the account balance exceeds $5,000. While this requires no immediate action, future contributions cannot be made. The range of investment options might be limited by the former plan’s offerings. An individual might also lose direct access to plan administrators, and the employer could move the account to a different provider.

Alternatively, funds can be rolled over into a new employer’s 401(k) plan, if the new plan allows incoming rollovers. Consolidating accounts into a single plan can simplify retirement savings management. This option maintains the tax-deferred status of the funds, and the new plan may offer different investment choices or lower administrative fees. However, not all new employer plans accept rollovers, so confirm eligibility with the new plan administrator.

Another strategy involves rolling over the 401(k) into an Individual Retirement Account (IRA). This provides greater control over investment choices, often offering a much broader selection of funds, stocks, and other securities than an employer-sponsored plan. A rollover IRA also maintains the tax-deferred growth of assets. This flexibility can be appealing for those seeking personalized investment strategies or lower fees.

The final choice is to cash out the 401(k) balance entirely, which means taking a taxable distribution. This results in immediate taxation of the entire amount as ordinary income. If the account holder is under age 59½, a 10% early withdrawal penalty applies, in addition to income taxes. Cashing out is generally not recommended due to its significant tax consequences and penalties, often resulting in a substantial reduction of the retirement savings.

Initiating and Completing the Rollover

To roll over an old 401(k) to either a new employer’s 401(k) or an IRA, contact the plan administrator of the previous employer’s 401(k) to initiate a distribution request. This involves filling out a specific distribution or rollover request form.

The most common method for moving funds is a direct rollover. In a direct rollover, funds are transferred directly from the former employer’s plan administrator to the new account custodian, such as an IRA provider or the new employer’s 401(k) administrator. The money is never handled by the individual, which helps avoid potential tax withholding issues and penalties. The check, if issued, is made payable to the new financial institution for the benefit of the account holder, ensuring funds remain within the tax-advantaged retirement system.

To facilitate a direct rollover, provide specific information about the receiving account. This includes the name of the new financial institution, the new account number, and sometimes wire instructions or an overnight mailing address. The transfer process typically takes a few weeks to complete, during which time the funds are moved between custodians.

An alternative method is an indirect rollover. In this scenario, funds are distributed directly to the individual, who then has a limited timeframe to deposit them into a new qualified retirement account. When an indirect rollover occurs, the former 401(k) plan administrator is required by the IRS to withhold 20% of the distribution for federal income taxes. This means the individual receives only 80% of their balance. This withholding is not a penalty but an advance payment of taxes.

To avoid the distribution being treated as a taxable withdrawal, the individual must deposit the full 100% of the original distribution, including the 20% withheld, into a new retirement account within 60 days of receiving the funds. If the full amount is not rolled over within this 60-day window, the un-rolled portion becomes taxable income and, if the individual is under age 59½, is subject to the 10% early withdrawal penalty. This often means using other personal funds to make up the difference until the withheld amount is recovered as a tax credit when filing income taxes.

Important Factors for Your Decision

Several factors warrant consideration when deciding the best home for a previous 401(k). Fees associated with different account types can significantly impact long-term growth. Employer-sponsored 401(k) plans may have administrative, record-keeping, and investment management fees. IRAs also have their own fee structures, including advisory fees, transaction fees, and expense ratios for investment products, which can sometimes be lower or higher depending on the provider and investment choices.

The breadth and flexibility of investment options are another important differentiator. While 401(k) plans offer a curated selection of investments, often mutual funds chosen by the plan sponsor, IRAs typically provide a wider universe of investment choices. This extensive selection in an IRA can allow for more personalized portfolio construction aligned with individual risk tolerance and financial goals. Conversely, some 401(k) plans might offer access to institutionally priced funds not available to individual investors, potentially providing a cost advantage.

Rules regarding Required Minimum Distributions (RMDs) also differ. Generally, RMDs from both types of accounts begin when the account holder reaches age 73. However, if an individual continues to work for an employer after age 73 and is not a 5% owner of the company, they may delay RMDs from that current employer’s 401(k) plan until retirement. This “still working” exception does not apply to IRA accounts or 401(k)s from previous employers.

Creditor protection also varies. Funds held in 401(k) plans generally receive strong protection from creditors under the Employee Retirement Income Security Act (ERISA). This federal law shields retirement assets in employer-sponsored plans from most creditors, including in bankruptcy proceedings. While IRAs also receive some creditor protection, the extent can depend on state laws and specific circumstances, often providing less robust or more varied protection than ERISA-covered plans.