Published on January 28, 2022
Here at Capitalize, we roll over more retirement accounts in one day than the average person might across their lifetime. These 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 401(k) – 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 no: 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 you can confidently roll over your 401(k), even if it’s greater than $20,500, which is the annual maximum for 2022.
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 $20,500 – this amount increases by $6,500 to $27,000 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 $6,000, with another $1,000 available to those over age 50 (total of $7,000). 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 retirement plan – a 401(k) or IRA – from one provider to another. This typically takes place when you’ve left a job and want to take your old 401(k) plan with you, either to your new employer’s 401(k) 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 it won’t count against any of our annual 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 have a few choices with regard to your old 401(k):
Roll over the account to either your new employer’s 401(k) plan or an IRA at an external provider.
Cash out your 401(k) – note that this will likely come with steep tax consequences, and if you’re under 59 ½, potentially steep penalties.
Do nothing, and leave your 401(k) where it is.
Notice that none of these options have anything to do with the annual contribution limits. 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 your rollover.
When you think about contributions and rollovers as entirely separate actions, both with different consequences, you can focus on optimizing your outcomes with both.
