Why Should I Roll Over My 401k Plan?

A 401(k) rollover moves retirement savings from an employer-sponsored 401(k) plan into another qualified retirement account. This often occurs when an individual changes jobs or retires, allowing them to consolidate or reposition assets. Understanding this process is important for managing long-term savings. This article explores the various aspects of a 401(k) rollover.

Understanding Rollover Advantages

Rolling over a 401(k) offers greater control over investment choices. Many employer-sponsored plans limit investment options, which may not align with an individual’s financial goals or risk tolerance. Moving funds to an Individual Retirement Account (IRA) provides access to a broader universe of investments, including mutual funds, exchange-traded funds (ETFs), stocks, and bonds. This expanded selection allows for personalized portfolio construction.

Another advantage is the potential for lower fees. Some 401(k) plans may carry administrative fees, record-keeping fees, or higher expense ratios. Rolling funds into an IRA may offer more transparent fee structures or lower overall costs, such as reduced advisory fees. Comparing fee schedules between the existing 401(k) and potential rollover destinations is advisable.

Consolidating multiple retirement accounts simplifies financial management. Individuals who have worked for several employers often accumulate multiple 401(k) plans, which can be cumbersome to track. A rollover allows combining these accounts into a single IRA, streamlining record-keeping, performance monitoring, and rebalancing. This consolidation makes it easier to maintain a comprehensive view of one’s entire retirement portfolio.

Choosing a Rollover Destination

A common destination for a 401(k) rollover is an Individual Retirement Account (IRA). Rolling funds into a Traditional IRA means the money continues to grow on a tax-deferred basis, similar to a traditional 401(k). Contributions and earnings are generally not taxed until retirement withdrawals begin.

Alternatively, some individuals roll pre-tax 401(k) funds into a Roth IRA. This is a taxable event, as the amount rolled over is included in taxable income for the conversion year. However, qualified withdrawals from the Roth IRA in retirement are entirely tax-free, including contributions and earnings. This can be advantageous for those who anticipate being in a higher tax bracket later in life.

Rolling a 401(k) into a new employer’s 401(k) plan is another option, if the new plan accepts rollovers. This choice appeals to individuals who prefer continued payroll deductions or wish to maintain higher contribution limits available in 401(k) plans compared to IRAs. Some new employer plans may also offer unique investment opportunities.

The transfer method, either direct or indirect, influences the rollover process. A direct rollover, also known as a trustee-to-trustee transfer, moves funds directly from the old 401(k) plan administrator to the new IRA custodian or 401(k) plan. This method is preferred because it avoids immediate tax withholding and eliminates the risk of missing a deadline.

An indirect rollover distributes funds directly to the individual, who then has 60 days to deposit the money into a new qualified retirement account. If an indirect rollover is chosen, the 401(k) plan administrator must withhold 20% of the distribution for federal income tax. Failure to redeposit the full amount, including the withheld 20%, within the 60-day window results in the untransferred portion being treated as a taxable distribution. This amount may also be subject to an additional 10% early withdrawal penalty if the individual is under age 59½.

Important Considerations Before Rolling Over

Comparing fees is a significant step before initiating a rollover. Individuals should assess the administrative and investment management fees of their current 401(k) plan against those of a prospective IRA or new 401(k) plan. While IRAs often provide more control over fees, some 401(k) plans may offer access to institutional-class funds with very low expense ratios.

Investment options also warrant careful review. While IRAs typically offer a broader range of investment choices, some 401(k) plans might include unique, low-cost institutional funds. Evaluating whether the new account’s investment selection adequately meets one’s needs, especially compared to the current 401(k)’s offerings, is important.

Creditor protection differs between 401(k) plans and IRAs. Employer-sponsored 401(k) plans generally receive strong protection from creditors under the Employee Retirement Income Security Act (ERISA). While IRAs also receive some protection, this can vary; federal bankruptcy laws provide shielding, but state laws govern protection in other civil judgments.

Understanding early withdrawal rules is important. The “Rule of 55” allows penalty-free withdrawals from an employer’s 401(k) if you separate from service at age 55 or later. This rule does not apply if funds are rolled into an IRA. IRAs have different rules for penalty-free withdrawals before age 59½, which can involve a complex calculation and a commitment to a set withdrawal schedule.

Net Unrealized Appreciation (NUA) is a specialized tax strategy for company stock held within a 401(k) plan. If a 401(k) contains employer stock, its appreciation can be taxed at lower long-term capital gains rates under certain conditions. Rolling over company stock into an IRA generally forfeits this NUA tax treatment, potentially resulting in a higher tax liability.

Required Minimum Distributions (RMDs) are another consideration. These distributions generally begin at age 73, though the exact age varies by birth year. RMDs apply to both 401(k)s and IRAs, with subtle differences in calculation and management. These considerations highlight the importance of careful evaluation and, in some cases, professional financial guidance before deciding on a rollover.

Steps for a Successful Rollover

Initiating a rollover begins by gathering all necessary information. This includes details about your current 401(k) plan, such as the account number and plan administrator contact. You will also need information for the target account, whether a new IRA or a new employer’s 401(k), including account numbers and custodian details.

The next step involves contacting your existing 401(k) plan administrator. Inform them of your intention to roll over funds and request the necessary forms and instructions. The administrator will provide paperwork to initiate the distribution and may require verification of the new account details for a direct rollover.

If rolling into a new IRA, open an account with a chosen brokerage firm or financial institution. This process usually involves completing an application and providing personal identification. Once the new account is established, its details can be provided to the 401(k) administrator to facilitate the transfer.

Completing the required rollover paperwork accurately is important. This typically includes distribution request forms from the 401(k) administrator and, for a direct rollover, transfer forms from the new account custodian. All forms must be filled out completely with gathered account information to prevent delays.

After submitting the paperwork, monitoring the transfer process is advisable. Confirm that the funds are moving correctly between the old and new accounts and that any specified timelines, especially the 60-day window for indirect rollovers, are met. Regular communication with both the old plan administrator and the new custodian can help track progress.

Once the funds have arrived in the new account, confirm their receipt and ensure they are invested according to your preferences. This involves verifying the correct amount was transferred and then allocating the funds to desired investments within the new account.

Retaining all tax documentation related to the rollover is important for tax filing purposes. The 401(k) plan administrator will issue Form 1099-R, which reports the distribution, and this form should be kept with other tax records.