By Stang Gappa
Updated on November 9, 2023
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Here at Capitalize, we roll over more retirement accounts in one day than the average person might over their lifetime. These retirement savings account balances range from less than $1,000 to even more than $100,000!
Because the account that you move your money into – like an Individual Retirement Account (IRA) or another employer-sponsored retirement plan – comes with annual contribution limits, we’re often asked: does a 401(k) rollover count as a contribution to the account you’re moving your money into? And, if so, how can anyone roll over a sizable 401(k) without exceeding these maximum limits?
The short answer to this question is, never: a 401(k) rollover is an entirely different action, and in truth, has nothing to do with the annual contribution limits that come with retirement accounts. That means a 401(k) rollover doesn’t count as a contribution, meaning you can confidently roll over your 401(k), even if it’s greater than $22,500, which is the annual maximum contribution for 2023.
Since 401(k) rollovers don’t count as IRA contributions, you can continue to contribute to your retirement accounts each year (adding sand to your pile) while rolling over old 401(k) accounts into your IRA (moving the pile, as needed). In doing so, you’ll only need to track your contributions up to the annual limits.
Every year, you have the opportunity to contribute a certain amount to your 401(k) and/or IRA accounts that count towards the “annual maximum.”
For 401(k)s, the annual maximum you can contribute as an employee is $22,500 – this amount increases by $7,500 to $30,000 if you’re over age 50. These contributions come out of your paycheck “before taxes”, and you’ll see it on your pay stub as “401(k) deferral” or “401(k) contribution”.
For Traditional and Roth IRAs, which are opened outside of your employment relationship, the annual maximum for contributions is $6,500, with another $1,000 available to those over age 50 (a total of $7,500). Traditional and Roth IRAs come with different tax considerations, but the contribution limit for both accounts is the same.
A rollover occurs when you move an existing qualified retirement plan – either 401(k) or IRA assets – from one financial institution to another. This typically takes place when you’ve left a job and want to take the 401(k) from your former employer’s plan with you, either to your new employer’s plan or an IRA opened at a provider of your choice.
A rollover can only happen after you’ve contributed money to one of your retirement plans and never happen before a contribution. In other words, you can’t roll over money you never contributed in the first place!
Think of rollovers as entirely separate from anything having to do with contributions to your retirement accounts, so a rollover won’t count against contribution limits – for your 401(k) or IRA.
Follow the below example for a real-world scenario:
Let’s imagine you’ve done a great job saving and have accumulated $50,000 in your employer’s 401(k) plan over the last several years. Then, you’re presented with a competing offer at another company which you immediately accept. Once you’ve left your job, you’ll have several options for your old 401(k):
Notice that none of these options have anything to do with the annual contribution limits. Since rollovers don’t count as contributions, the $50,000 balance, if you decide to roll it over, is a separate action that won’t affect your ability to contribute to your new 401(k) – or an IRA – throughout the year.
A rollover refers to moving the location of your account, while a contribution refers to adding to the account. An analogy can also help to discern the difference:
Say you’re at the beach, and you’re shoveling sand into a pile. Every year, you’re able to add a certain amount of sand to the pile. These are your contributions.
But then, your family decides to move to another section of the beach. As a result, you decide to take the entire pile – or even a section of it – to the new area (ignore the difficulty you’ll inevitably encounter when trying to move the pile of sand). This is a rollover and can include moving to a different “beach” -or brokerage – entirely.
You’ll also want to be aware of the type of IRA you’ll be moving your retirement savings into – traditional 401(k)s are typically moved into traditional IRAs, and Roth 401(k)s are typically moved into Roth IRAs. If you’re unsure of the type of 401(k) you have, you can contact your plan administrator for assistance.
There are additional considerations if you plan on doing a 401(k) rollover from a pre-tax account to an after-tax Roth IRA. When you roll funds from a traditional 401(k) or traditional IRA into a Roth IRA, you’ll need to recognize the money you transfer as income. Since your original contributions were made in a tax-deferred status, you’ll need to pay Uncle Sam ordinary income tax for the ability to hold that money in a tax-free Roth account.
Fortunately, rollovers do not count as contributions toward your Roth IRA. You’d be able to roll over any amount to your Roth while still contributing the annual maximum (provided you’re able to make direct Roth IRA contributions given your MAGI from earnings).
Also note that Roth accounts are not subject to Required Minimum Distributions (RMDs) in the same way that traditional, pre-tax retirement accounts are.
If you have questions about how your 401(k) rollover to a Roth IRA could impact IRA contribution limits, it’s best to consult a tax professional. They will also be able to help with navigating potential tax implications, filing tax returns, maximizing your federal tax deductions, and more.
When you think about contributions and rollovers as entirely separate actions, both with different consequences, you can focus on optimizing your outcomes with both. A rollover IRA allows you to move retirement savings from your old employer-sponsored retirement plan into an IRA, typically with more investment options and investment choices, including mutual funds and ETFs.
A rollover can be classified as either a direct rollover or an indirect rollover. Some people may consider taking early withdrawals, but be aware that the IRS may subject you to an early withdrawal penalty, and you’ll potentially pay taxes if you don’t meet their requirements. It may be wise to consult a financial advisor first before doing so.
If you want to consider a 401(k) rollover that doesn’t impact IRA contributions, Capitalize can manage the entire rollover process.
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