If you’re in the process of changing careers or employers, you may be wondering what to do with your old employer-sponsored 401(k). Once you leave your job, you won’t be able to contribute to the account anymore, leaving you with two main options: leave it be or roll it over to a different retirement plan.
Making the right money moves now with your retirement savings is important, as it will help ensure that you are financially secure once you say goodbye to a steady earned income. To help you make the right decision, we’ve broken down some of the benefits of rolling over your 401(k).
What is a 401(k)?
Simply put, a 401(k) is a tax-advantaged retirement plan. Employers around the country include them in their benefits package, making them available to their employees at little or no cost. Some employers may even contribute to their employees’ 401(k)s by matching the money that they put into their account.
Contributions to a traditional 401(k)s are done ‘pre-tax’, which means that the money is put into your retirement account before taxes are taken out of your paycheck. Come tax season, this translates to a smaller tax burden. The trade-off is that your withdrawals will be taxed in retirement. With a Roth 401(k), contributions are done post-tax, but your withdrawals in retirement will be tax-free.
Since 401(k)s are tied to an employer, when you leave the job, you can no longer contribute to it. That leaves you with two choices: leave it there or roll it over to a new account.
How to Rollover a 401(k): Direct Rollovers vs. Indirect Rollovers
There are two main categories of rollovers: direct and indirect.
- A direct rollover occurs without you ever touching the money. The money is simply transferred into the new account and is never in your personal possession.
- With an indirect rollover, the money is transferred to you via check. This may sound like a fun idea, but there are a lot of risks involved with this— so much so that most financial advisors say to avoid this option at all costs.
The money isn’t yours to keep without facing penalties. If you don’t put the money into a new retirement savings account within 60 days, you will start owing early withdrawal penalties, income tax, and excess contribution tax. You can also be on the hook for some of these charges if you do more than one indirect rollover in a 12-month period or if you try to split the money among multiple accounts.
For this reason, doing a direct rollover is usually the best option. Direct rollover eliminates all of the possible risks.
Types of 401(k) Rollovers
The next decision you need to make is where you want to roll your money to. With 401(k) rollovers, there are two accounts that you can move your money to: an IRA or another 401(k).
Rolling Over a 401(k) to an IRA
Like a 401(k), an IRA is a tax-advantaged retirement plan. One of the most notable differences between the two retirement plans is that an IRA is not tied to any one employer.
Here are five advantages to rolling over your 401(k) into an IRA:
- You’ll ensure that you’re getting up-to-date information. Leaving your money in your old account can keep you out of the loop once you leave the employer. It’s easier to keep up with your own IRA since communications come straight to you and don't filter through your company.
- Enjoy fewer fees, restrictions, and rules. IRAs come with fewer fees and restrictions than a 401(k). Since IRAs are standardized by the IRS, they are fairly simple to understand. On the other hand, 401(k)s are set up by employers, so specific rules can vary and be hard to navigate.
- You will have more investment options. A 401(k) typically has limited options when it comes to how you invest your money. Unless you’re working for a huge corporation, you’ll probably only have the choice between a few mutual funds. An IRA can open up more investment opportunities like stocks, bonds, exchange-traded funds, and more mutual funds.
- You can roll it over into a Roth IRA. If you’re looking to put your money in a Roth IRA, you usually have to roll it into a traditional IRA first.
- You will have more estate planning control. With an IRA, your beneficiaries will have more payout options than they would with a 401(k). This can give you more control over your estate planning and help ease the burden on whoever is left with your money when it comes time for them to pay taxes.
Transferring Your Old 401(k) to a New 401(k)
If you go to work somewhere else that offers a 401(k), you may be able to simply roll your money over into your new account. Note that this isn’t allowed with all 401(k)s. Your new employer’s plan may not allow rollovers.
If it’s a possibility, there are two pros to transferring your money to a new 401(k):
- It’s easy. If you’re going to be contributing to your new employer’s 401(k), simply rolling over your money into one account makes managing your investments easier.
- If your new employer covers fees, it could be cheaper. Some— but not all— employers foot the bill for administrative fees for a 401(k). If this is the case, you can save on fees by transferring your funds to the new account.
Regardless of which new plan you choose, rolling over your funds is almost always the best option. Unless your old employer had a stellar plan that can’t be beat, rolling over funds will give you more control over your money. Be sure to consult with your financial advisor to make the best decision for your financial situation.
Ready, Set, Roll Your 401(k)
Rolling over your old 401(k) doesn’t need to be an intimidating process. Doing so can help you keep track of your funds and provide you with more investment options. A direct rollover can be easy whether you’re putting it in a new IRA or another 401(k). Rest well knowing that you’ll be setting yourself up for success and financial stability when retirement rolls around!
* Non-deposit investment products and services are offered through CUSO Financial Services, L.P. ("CFS"), a registered broker-dealer Member FINRA/SIPC and SEC Registered Investment Advisor. Products offered through CFS: are not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including possible loss of principal. Investment Representatives are registered through CFS. The Credit Union has contracted with CFS to make non-deposit investment products and services available to credit union members.
Before deciding whether to retain assets in an employer-sponsored plan or rollover to an IRA an investor should consider various factors including but not limited to: investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Before you elect to open an IRA account and engage your investment representative, please review all account statements and disclosure documents related to the IRA and services to be provided under a new relationship and consult with a qualified tax advisor as needed. If transferring an existing retirement plan into an IRA, you should be aware that (i) Those assets will no longer be subject to the protections of ERISA (if applicable) (ii) depending on the investments and services selected for the IRA, you may pay more or less in transaction costs than when the assets are in the Plan, (iii) if you are between the age of 55 and 59 ½, you would lose the ability to potentially take penalty-free withdrawals from the plan, (iv) if you continue working past age 70 ½ and transferred your plan assets to a new employer’s plan, you would not be subject to required minimum distribution and (v) withdrawing assets directly would be subject to federal and applicable state and local taxes and possibly be subject to the IRS penalty of 10% if under age 59 ½.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.