What Is Exchange In and Exchange Out in a 401(k)?
Learn how to manage your 401(k) investments by understanding the process of moving funds between different options within your retirement plan.
A 401(k) plan serves as a tax-advantaged retirement savings vehicle offered by many employers. These plans allow individuals to contribute a portion of their pre-tax salary, which can then be invested in a range of available options.
Defining Exchange In and Exchange Out
Within a 401(k) account, an “exchange” refers to the movement of existing money from one investment option to another, entirely within the same retirement plan. This action involves reallocating funds already invested, distinct from making new contributions or taking withdrawals.
An “exchange in” specifically describes the act of directing funds into a particular investment option or fund within the 401(k) plan. For instance, if an investor decides to shift a portion of their holdings from a bond fund into a stock mutual fund, the movement of money into the stock fund is considered an exchange in.
Conversely, an “exchange out” signifies the act of moving funds away from a specific investment option or fund within the 401(k) plan. Using the previous example, the transfer of funds out of the bond fund would be an exchange out.
Both “exchange in” and “exchange out” are interconnected components of a single internal transfer action. Funds cannot be moved into one investment without simultaneously being moved out of another within the same plan. These internal transactions do not typically incur immediate tax consequences, as they occur within the tax-advantaged structure of the 401(k) itself.
How to Perform 401k Exchanges
Performing an exchange within a 401(k) typically involves interacting with the plan administrator’s platform. Most commonly, participants can initiate these transactions through a secure online portal provided by the administrator. Alternatively, some plans may offer the option to complete exchanges via phone call with a representative or by submitting specific paper forms.
When using an online portal, the process generally begins by logging into the account and navigating to the investment or portfolio management section. Within this area, there is usually an option labeled “exchange,” “transfer,” or “reallocate investments.” The system will then prompt the user to select the investment option from which funds will be moved (the source fund) and the investment option into which the funds will be transferred (the destination fund).
Participants must specify the amount or percentage of funds they wish to exchange. Once the selections are confirmed, the transaction is submitted for processing. Exchanges involving mutual funds often execute at the close of the trading day, based on that day’s closing prices. The actual settlement of mutual fund trades typically occurs by the next business day. After an exchange is completed, the plan administrator usually provides a confirmation.
Why 401k Exchanges Occur
Individuals often perform 401(k) exchanges to adjust the allocation of their existing investment funds within the account. These adjustments are a common aspect of managing a retirement portfolio over time. The primary purpose of such exchanges is to maintain a desired investment mix.
One frequent reason for exchanges is portfolio rebalancing. Over time, the performance of different investments can cause the original asset allocation to drift, meaning some investment types may grow to represent a larger or smaller percentage of the total portfolio than originally intended. Exchanges allow participants to sell portions of overperforming assets and buy more of underperforming ones, bringing the portfolio back to its target percentages.
Exchanges also occur to reflect changes in an individual’s financial situation or time horizon. As someone approaches retirement, they might choose to shift their portfolio from investments typically associated with higher growth potential to those generally considered more stable. This adjustment helps align the portfolio with a shorter investment timeline.
Market movements can also prompt exchanges. Significant shifts in market conditions may lead individuals to reallocate funds to maintain their preferred asset distribution, especially if their portfolio’s composition has been altered by these movements. Additionally, if the 401(k) plan introduces new investment options, participants may perform exchanges to take advantage of these new choices and diversify their holdings.