How to Rollover a 401(k) to an IRA

LAST REVIEWED Jun 08 2020 8 MIN READ

By The Human Interest Team

Congratulations on moving into the next phase of your career! Whether you’re transferring to a new company, starting your own business, taking some time to travel the world, or beginning any other non-retirement venture, you may be wondering what to do with the 401(k) from your previous employer. When you leave your employer for any reason other than retirement, there are four main options: cash out, leave it with your previous employer, transfer it to your new employer, or roll it into an IRA or Roth IRA.

Cash Out Your 401(k)

Cashing out your 401(k) is almost always a mistake. Unless you have extenuating circumstances that place you in a true financial emergency, like being laid off and short of money with no other recourse, then you do not want to cash out your 401(k). If you are in a situation where you need to cash out, only take the minimum amount you need and transfer the rest to an IRA.

When you cash out your 401(k) the taxes and penalties are substantial. The funds will be taxed like ordinary income at your current tax rate. You’ll pay a 10% penalty fee, unless you’re no longer working and at least 55 years old or still working and at least 59 1/2 years old. Additionally, you are losing future funds since your account is no longer growing. You may also want to think about how cashing out will impact your plan to retire.

Keep Your 401(k) With Your Previous Employer

If you really like the way your current 401(k) is set up with your previous employer and your fees are low, then leaving it alone may be the right choice for you. If you choose this route, you don’t need to do anything. Just continue to actively monitor your investments and your plan’s performance and keep an eye out for any significant changes. Additional advantages include:

  • Legal protection – 401(k)s are protected from creditors, bankruptcy, and lawsuits.

  • Self-employment – leaving your 401(k) is the easiest option, especially if you like your 401(k) plan.

  • Maintaining performance – stick with your 401(k) if it’s outperforming the markets over time.

  • Tax advantages – if you leave your employer the year you turn 55 and want to start withdrawing funds before you turn 59 1/2, the withdrawals will be penalty-free.

Some reasons not to keep your 401(k) with your previous employer include:

  • The difficulty of keeping track of multiple retirement accounts.

  • No longer being able to contribute to the old plan.

  • No longer receiving company-matched contributions.

  • No longer being able to take out a loan from the plan.

  • Not being allowed to make partial withdrawals.

Transfer Your 401(k) to Your New Employer

This can be a good idea if you’ve taken a position at a new company and their 401(k) plan accepts rollovers, especially if the new 401(k) plan has lower fees and the investment options are better. There are some other benefits to rolling your old 401(k) into your new company-sponsored 401(k), such as:

  • Ease – if you’re used to having a plan administrator manage your account and automatic payroll deductions, this can continue.

  • Higher contributions – the contribution limits on a 401(k) are much higher than with an IRA.

  • Retirement age – if you plan to work past age 72 then you can delay taking Required Minimum Distributions with an employer-sponsored 401(k).

  • Loan access – you may be able to borrow against your old or new 401(k) account, depending on the plan design.

Once you’ve looked into your new company’s 401(k) plan, you may decide against rolling it over if:

  • The investment choices are limited.

  • The fees are higher than what you’re already paying.

  • The fees are higher than rolling over to an IRA or Roth IRA.

  • Rolling over company stock comes with unusually high taxes.

Roll Over Your 401(k) to an IRA or Roth IRA

Typically, an IRA or Roth IRA offers a much larger selection of investment options than a 401(k) and they have much lower fees. IRAs allow almost any type of asset including mutual funds, exchange-traded funds, stocks, bonds, real estate investment trusts (REITs), certificates of deposit (CDs), and annuities. With a self-directed IRA, some plans even allow alternative investments like physical property, oil and gas leases, or purchased commodities.

If you’ve decided the best option is to roll your 401(k) into a new or existing IRA or Roth IRA account, you’ll have to decide which one is best for you. Essentially, the difference is between paying income taxes now with a Roth IRA or paying income taxes later with a traditional IRA. Your age, time until you retire, and risk tolerance should be taken into consideration.

A helpful tip is to think about where you are financially now compared to where you expect to be in the future. For example, if you’re in a high tax bracket right now and expect to retire and start using the funds in less than five years, then a Roth IRA isn’t the best choice. You’ll end up paying a high tax bill now and won’t have enough time to benefit from tax-free growth. Conversely, if your current tax bracket is lower, but you expect to be in a much higher one later, then paying taxes now may be a smaller amount than down the road. Here’s a great resource to help you decide between a traditional IRA or a Roth IRA.

While looking at all the different 401(k) rollover options and deciding whether to cash out, keep your old plan, roll over to a new 401(k) plan, or roll over to an IRA or Roth IRA, try to keep the following in mind:

  • Which option will result in the least amount of fees?

  • Which option provides the best range and quality of investments?

  • How does your age and retirement plan affect your options?

  • What are the plan designs of both the old and new retirement account?

The wrong retirement decision could end up costing you, so you may want to consult with a specialist who can help you make the best decision for your specific circumstances. The professionals at Human Interest are experts when it comes to retirement accounts and are ready to offer you guidance — just contact us!

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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