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Quick Summary

  • A 401(k) IRA Rollover is when you move money you saved in a 401(k) at work to an IRA at a bank or brokerage.
  • Most people do a 401(k) rollover to a Traditional IRA when they change jobs or retire.
  • There are rules about how to do rollovers. If you break the rules, you might have to pay more in taxes or face penalties.

Introduction

When you leave your employer, you might wonder what to do with the money you saved for retirement in your 401(k). We’ll review all of the details:

Rollover Options

You have four main options with your 401(k) when you leave an employer:

  1. Cash it out. Cashing it out is usually a mistake. On a traditional 401(k) plan, you’ll have to pay taxes on all of your contributions plus tax penalties for early withdrawals if you’re under 59½. This means you’ll lose all the benefits you worked so hard to accrue.
  2. Keep it in the original employer’s plan. Especially if you have an excellent 401(k) with good investment choices and low fees, this could be a good option.
  3. Roll it over into your next employer’s 401(k). If you’re moving to a different company, see whether its rules let you transfer your old balance to your new plan. Only consider this if your new plan is excellent.
  4. Roll it over into an IRA. With your own IRA, you have the most control. You can pick which company you want to work with and where you want to invest your money. For most investors, doing a rollover into an IRA they control makes sense, especially if you stick to low-cost index funds. Fees on most IRAs are lower than for 401(k)s. For help deciding whether to do a rollover, see What Is a 401(k) to IRA Rollover? Should You Roll Over?

Rules on Kinds of Rollovers

There are different kinds of retirement accounts. If you are wondering whether a rollover is allowed or whether you will have to pay taxes, remember that doing a rollover between accounts that are taxed in similar ways usually doesn’t trigger taxes.

Most rollovers are of traditional, tax-deferred 401(k)s or other employer plans like a 403(b) to Traditional IRAs. You don’t owe taxes on money saved in 401(k)s or Traditional IRAs until you retire and start withdrawing the money.

You can also do a rollover from a Roth 401(k) to a Roth IRA. That doesn’t trigger taxes, either.

To do a rollover from a 401(k) to a Roth IRA, however, is a two-step process. First, you roll over the money to an IRA, then you convert it to a Roth IRA. That’s called a conversion and has separate rules.

There are other kinds of retirement accounts, too, such as SEP or SIMPLE IRAs You can see a summary of which kinds of rollovers are allowed in this IRS chart.

How to Do a Rollover

A rollover from your 401(k) plan is easy. You pick a place, like a bank, brokerage or online investing platform, to open an IRA. Let your 401(k) plan administrator know where you have opened the account.

Then, you can do a direct rollover. This means that your plan administrator sends the money directly to the IRA you opened at a bank or brokerage. Or, he or she may cut you a check made out to your account, which you deposit. Going directly (no check) is the best approach.

You can also do a rollover from a distribution, also called an indirect rollover. In this case. your employer will give you a check made out to you. Taxes will be withheld, and you will have to report the distribution as income on your income tax return. You can still avoid taxes, if you do a rollover of the money into another retirement account within 60 days and make up the money withheld from another source.

Some people do an indirect rollover if they want to take a 60-day loan from their retirement account.

For more on how to report an indirect rollover on your taxes, check this IRS site.

Contribution Limits

Once you have established a rollover IRA, you can make contributions to it up to the annual limit. For 2017, the contribution limit is $5,500—$6,500 if you are 50 or over. If you are doing a different kind of rollover into a different kind of IRA or retirement plan, you can check out contribution limits here.

The Most Important Rule

The most important rule is: Don’t cash out. Unless you are in a real crisis or you meet the criteria for emergency withdrawals, you should keep your money in a tax-deferred account. That can be a 401(k) or an IRA. If you cash out for good, you will pay taxes and penalties. You’ll be robbing your future self of the money you will need to live on in retirement.

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