Human Interest - The 401(k) provider for small and medium-sized businesses

How to Roll Over Your 401(k)

By Damian Davila -

As U.S. workers tend to hop between jobs more often, they need to be better prepared to rollover their 401(k) plans. When taking a look back at the last six years, U.S. wage and salary workers stay with their current employer for a median of 4.6 years and one-fifth of workers are laid off. Knowing how to roll over your 401(k) is an essential step to maximize your nest egg. From understanding how vesting works to knowing the required steps to do an indirect rollover, here is review of key steps to roll over a 401(k) after separation from an employer.

Step 1: Find out your fully vested account balance

When you check the account balance of your 401(k) online or on a paper statement, you may not be looking at the amount that you would take with you if you were to quit, be fired, or laid off today. While all of your personal pre-tax or post-tax contributions are always fully vested, matching contributions and profit sharing contributions from your employer may be subject to a vesting schedule.

Take a look at the provisions of your 401(k) plan regarding employer contributions because those provisions may state that if you leave within a certain period of time, you’ll lose some of the proceeds. Under cliff vesting, employer contributions only become fully vested after a minimum number of years, and under graded vesting, employer contributions are gradually vested over time.

If you have a dispute about 401(k) vesting with your employer, contact the Employee Benefits Security Administration (EBSA) for assistance.

Step 2: Take stock of unpaid loans from your 401(k)

Here’s another reason why it doesn’t make sense to take a loan from your 401(k). If your plan allows you to take a loan, you’ll generally have up to 5 years to pay the loan back in full. However, if you separate from your employer, the unpaid loan balance becomes due within 60 days.

In the event that you’re unable to pay back the remaining balance, it becomes an early distribution, triggering income taxes and, if under age 59 1/2, a 10% penalty from the IRS. Some states may charge additional income taxes and penalties. And you can’t roll over unpaid loans to an IRA or 401(k), effectively reducing your nest egg.

This is why when doing a cost-benefit analysis of accepting a new job offer, make sure to include the opportunity the cost of losing a non-vested portion and paying income taxes (and penalties if applicable) of early distributions of your nest egg.

Keep in mind: Leaving the money in your old 401(k) can work against you

Even when you part ways with your employer in the best possible terms and are very happy with your old 401(k) plan’s rules and fees, not rolling over your vested balance to a new retirement account can work against you in many ways.

If you’re concerned about company securities, including stocks, bonds or debentures, that would be subject to income tax when withdrawn from your old 401(k), consult your plan administrator or financial advisor for tax scenarios to defer tax payment on the appreciation of those company securities.

Keep in mind: You can still roll over cashouts from a 401(k)

Don’t spend that check! If you spend a $900 cashout instead of rolling it over into an account earning 8% tax-deferred earnings, your retirement fund could end up more than $9,000 short after 30 years. The bigger is your cashout spent, the higher is your opportunity cost.

If you’re able to find a new employer offering you a 401(k) or IRA, or you open a new retirement account that accepts the cashout check within 60 days from your last day of employment, then take advantage of an indirect rollover to recoup withholding and avoid paying penalties.

You’ll have to deposit the entire check and come up with the 20% that your employer withheld. By doing completing an indirect rollover within the time limit, the IRS will refund the entire withholding in your next tax return.

Step 3: Do the math

When evaluating 401(k)s and IRAS, consider the following:

401(k) IRA Roth IRA
Maximum contribution for 2018 $18,500 $5,500 $5,500
Maximum catch-up contribution for age 50+ for 2018 $6,000 $1,000 $1,000
Tax deductible contributions Yes Yes, if you qualify No
Required minimum distributions can be delayed beyond age 70 1/2 Yes, if working No Yes
Taxes at time of rollover No No Yes
Options for early distributions without penalty Virtually none Several Several
Protection from claims by creditors Yes Only in bankruptcy Only in bankruptcy
Limit on rollovers per year None One One

For a full comparison of these plans see: 401(k) vs IRA: How to Decide

It’s key to figure out how much you’re currently paying in fees and expenses for your 401(k). Use that number to determine how much more or less in fees and expenses you would pay under the new plan. While you have no control on actual returns, you can always control actual expenses!

Step 4: Do a direct rollover to a 401(k) or IRA

This is the most cost-effective way to do a 401(k) rollover. A direct rollover empowers you to choose a retirement account that best suits your needs, minimize plan fees, maximize potential returns, and continue growing your money tax-deferred.

No matter what is the retirement account of your choice, check with your new plan administrator whether or not your 401(k) balance is eligible for a rollover. Physical checks for rollovers are still mailed via snail mail and selecting an ineligible plan recipient could cause you to miss the window to complete a direct rollover.

Some meta-steps:

Each provider is different, but make sure to ask these questions, at the very minimum:

IRS Form 1099-R acts as a receipt to show that your money was rolled over and not withdrawn. Once it’s sent to you, you should file it when you do your taxes as proof that the money was rolled over, so that you won’t have to pay taxes on this transaction.

The Bottom Line

Be patient with the rollover process and don’t be surprised if you may have to jump on the phone a couple of times with your former and new plan administrators. Focus on the retirement account that is best suited for your long-term retirement saving plans and not on the one offering the least amount of paperwork.

Avatar Damian Davila

Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.

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