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, 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 (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 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 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 your rollover.
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 IRA into a Roth IRA, you’ll need to recognize the money you transfer as income. Since your original contributions were tax-deferred, you’ll need to pay Uncle Sam income tax for the ability to hold that money in a tax-free Roth account.
So while rollovers don’t count as contributions, a sizeable rollover to a Roth IRA could put your income over the limit to be eligible for annual contributions. If your rollover puts your income for the tax year 2023 over $153,000 as a single filer or $218,000 if you’re married filing jointly, you’ll not be eligible to make any Roth IRA contributions in that tax year. If you have questions about how your 401(k) rollover to a Roth IRA could impact contributions, it’s best to consult a tax professional.
When you think about contributions and rollovers as entirely separate actions, both with different consequences, you can focus on optimizing your outcomes with both. If you want to consider a 401(k) rollover that doesn’t impact IRA contributions, Capitalize can help.