Rollover

A rollover occurs when a plan participant transfers the funds in an existing retirement account to a new retirement plan or IRA. It’s a key process for managing your retirement savings as your career or financial situation evolves.

What does a 401(k) rollover mean in practice?

A 401(k) rollover is the process of moving your hard-earned retirement money from one qualified retirement account to another. This action most commonly happens when you leave a job and need to decide what to do with the 401(k) savings from your previous employer, or if your old plan is terminated. 

The main goal of performing a rollover is to keep your retirement savings tax-deferred. This means you avoid paying taxes on the money until you actually withdraw it in retirement, allowing your investments to potentially grow more over time. You may also want to combine multiple accounts into one to easily keep track of your retirement savings.

Why would you consider doing a 401(k) rollover?

There are several reasons why an individual might choose to perform a 401(k) rollover:

• More investment options: Your new 401(k) or an Individual Retirement Account (IRA) might offer a broader range of investment choices compared to your old employer's plan, giving you more control over how your money is invested.

• Consolidation and simplicity: If you've had several jobs, you might have multiple old 401(k) accounts scattered around. Consolidating these into one new 401(k) or an IRA can significantly simplify your financial life, making it easier to track and manage your retirement savings.

• Maintain tax-advantaged status: A rollover ensures that your retirement funds maintain their tax-advantaged status. If you were to cash out your old 401(k), you may face additional income taxes, and early withdrawal penalties if you're under age 59½.

What are the common types of rollovers?

When you decide to roll over your 401(k), you have two main options:

• Direct rollover: This is often the preferred method. In a direct rollover, the funds are transferred directly from your old retirement plan administrator to your new retirement account (either a new 401(k) or an IRA). This method avoids any taxation on the distribution or potential penalties.

• Indirect rollover (60-Day rollover): With an indirect rollover, your previous plan administrator sends a check made payable directly to you. While this sounds straightforward, there are major complications:

• Mandatory 20% tax withholding: By law, your old plan is required to withhold 20% of the distribution for federal income taxes before sending you the money, plus any applicable state taxes. This means the check you receive will only be for 80% or less of your retirement account. * 

  • The 60-Day Rule: You have 60 days from the day you receive the funds to deposit up to the full 100% of your original account balance into a new retirement plan or IRA. To do this, you must come up with the missing 20% (or more) in withheld taxes from your own pocket. You can then potentially reclaim the taxes that were withheld when you file your income taxes for the year.

Consequences: If you only deposit the 80% you received, the missing 20% will be considered a taxable distribution. It will be subject to ordinary income tax and, if you are under age 59½, a potential 10% early withdrawal penalty