Navigating the labyrinth of retirement accounts, from 401(k) plans to Individual Retirement Accounts (IRAs), can feel daunting, particularly when career transitions lead to the question of what to do with retirement savings from an old 401(k).
Should you leave it as it is, roll it over into a new 401(k) or an IRA, or even cash it out? Each option has unique benefits and drawbacks, all of which are entwined with complex tax implications, contribution limits, and sometimes, time constraints.
Understanding these nuances not only helps in making a prudent decision for your financial future but also ensures compliance with IRS regulations to avoid penalties. Let’s demystify the process, examining the different strategies and considerations for handling your 401(k) after leaving a job.
First, there is no set time limit to roll over your 401(k) retirement account once you’ve left your employer.
Some of your options in this scenario include:
As long as you’re aware of the account’s existence, and the 401(k) plan offers a nice selection of investments with low fees within that financial institution, you have every right to leave your existing retirement savings plan as it is.
If it’s administratively complicated to move the account, leaving it alone might be a completely fine option.
Rolling over or transferring your 401(k) to an IRA is a very common choice for people starting a new job, especially if they have the desire to break entirely from their previous employer. The investment menu tends to be a bit wider at most IRA providers since most IRAs include options to invest in mutual funds, ETFs, and other classes that may not be available in your old plan, so this option is appealing in a variety of circumstances. Note that tax consequences may arise depending on the type of IRA account you’re rolling into.
Sometimes new employer plans will allow you to “roll in” your previous employer’s plan. This can be an easy way to consolidate if you want to have everything in one place — assuming the tax status of the two accounts is the same for the rollover contribution. For example, rolling a traditional, pre-tax 401(k) into a traditional pre-tax IRA would trigger no tax consequences in the rollover process. There are some pros and cons to rolling over a 401(k) into a new 401(k) plan that you should be aware of.
Depending on your needs, you do have the option of taking cash out to fund a current expense — but beware that this comes with taxes and penalties from the IRS if you’re under the age of 59 ½.
If you are age 55 or older, most (if not all 401(k)) plans will allow you to follow the Rule of 55, which allows penalty-free distributions from your 401(k) after you attain age 55. Note that you’ll also need to be separated from your employer for this to be on the table.
401(k) plans tend to be very employer-specific: that is, you may have additional options depending on the rules of your specific plan. For instance, some plans may allow loans with certain caveats. To find out if you have any other options, it’s best to contact your 401(k) plan administrator directly.
There are a limited number of circumstances where your employer may have the right to move your money without your consent. If your balance is less than $1,000, your employer may simply send you a check for the balance; if your balance is less than $5,000, they may have the ability to roll it into an IRA of their choice. Make sure to read the details of your 401(k) plan if your balances are in this range.
If you’re performing a direct rollover of your retirement funds from your current 401(k) provider into an IRA, there is no rollover time limit to complete the transaction of your rollover contribution.
However, if you plan to do an indirect rollover, you could need to follow the 60-day rule. As discussed, you have the following rollover options:
A direct rollover involves moving money from 401(k) plan-to-plan or from a 401(k) to an IRA retirement savings account and is the recommended way to roll over an old 401(k). Usually, it happens in one of two ways:
You’ll contact your former employer-sponsored retirement plan provider and request a check for the entire account balance made out to your new provider (for your benefit) as a rollover contribution. They’ll send a check directly to your new company and deposit it into your new account. No taxes are withheld and it’s generally considered penalty-free and rollover fees are fairly uncommon.
You’ll request a check in the same manner as described above (made out to your new provider for your benefit), except you’ll receive the check directly and will be required to forward it along to your new company yourself. Again, no taxes are withheld and it’s generally considered penalty-free.
An indirect rollover is a bit more complex and can get you into hot water if you don’t follow the rollover rules very carefully. It’s usually best to first speak with a tax advisor to understand potential tax penalties.
You’ll request a check from the old employer’s retirement plan 401(k), except in this case the money is paid directly to you as an individual. Taxes will be withheld. Then, you’ll need to deposit the full amount withdrawn, before taxes, into a new 401(k) or IRA retirement savings account within 60 days to avoid taxes and penalties.
In other words, if you have a $100,000 401(k) balance, and you request an indirect rollover, your plan administrator will send you a check less any tax withholding (usually 20%). You’d receive $80,000 into your bank account in this example.
But to avoid taxes and penalties, you’d need to roll over $100,000 to a new retirement account within 60-days of your initial withdrawal. You’d then receive your tax withholding back at the time you file your tax return.
Given the complexities of indirect rollovers, we usually recommend going for a direct rollover where and if applicable.
The main advantage is that you’ll have time to re-evaluate your new circumstances before making any substantial changes to your financial accounts. Leaving a job is often a milestone life event, so you may want to take time to focus on a new role or new life chapter before rearranging your finances and optimizing your available investment choices.
You’ll also have time to consider any tax consequences of rolling over your account. Careless planning can lead to unforeseen tax consequences — like a big tax bill — so be sure to know the mechanics of your rollover before you start filling out the paperwork to aim for a tax-free transfer.
If your previous employer-sponsored retirement plan had a 401(k) offering with expensive investment options or otherwise high fees, you’ll want to look into moving the money to an IRA or your new 401(k) plan as soon as you reasonably can. The longer you leave the money there, the more the fees are working to eat away your hard-earned investment returns.
Next, leaving the account at your old employer can sometimes lead to it being forgotten. At the same time, a financial life with scattered accounts is much more difficult to manage. It’s smart to consolidate to the extent possible and be proactive about optimizing the number of accounts you have.
There usually isn’t a lot of upside associated with waiting, so it’s a good idea to create a plan and consolidate as soon as is practical for you. If you do decide not to roll over your old 401(k), make sure that it’s an active choice. So whatever you decide to do, be sure to give it some thought first.
The 60-day rollover rule is applicable to indirect rollovers only and is usually used in the context of taking a short-term loan from your retirement plan. You don’t necessarily have to leave a job to attempt an indirect rollover.
Say you withdraw money from your 401(k). Also, imagine that you receive the money directly into your own bank account.
Within 60 days, you’ll need to deposit the entire amount withdrawn, before taxes, to a new retirement plan to avoid taxation (and an early withdrawal penalty if it’s an early distribution). When you take money out of a retirement plan early, you’re subject to a 10% penalty if you’re below 59 ½, unless it’s for a qualified exception.
Due to the nature of indirect rollovers, you’re only allowed to complete one per 12-month period. This one-per-12-months rule only applies to indirect rollovers, not to the more traditional direct rollovers as described above.
Note that this does not mean you only have 60 days to roll over your 401(k) after leaving a job. This time limit only applies to indirect rollovers. Many people leave old 401(k) plans in place for many years before deciding to move them.
The significant takeaway here is that a direct rollover is your best bet for rolling over an old 401(k), while an indirect rollover is more applicable in the context of taking a short-term loan from your retirement plan — one that you’re absolutely sure you can pay back!
Say you withdraw $50,000 in retirement funds from your employer’s 401(k) plan in an attempt to complete an indirect rollover. 20% of the withdrawal ($10,000) is withheld in the process for federal taxes.
It’s your responsibility to deposit the full $50,000 to your new retirement plan (even though you only received $40,000) within 60 days or you’ll be liable for taxes and penalties on the distribution.
Failure to pay back the full amount could result in the entire withdrawal being labeled as taxable income, taxed at your ordinary income rate. Again, if you’re below 59 ½, you’ll also face an early withdrawal penalty of an additional 10%. Note that these are general rules and in some cases, there may be exceptions.
Yes. Direct rollovers — where money is moved from provider to provider — are not subject to this rule. You’re simply moving tax-advantaged money from one company to another. There’s no true withdrawal taking place to disturb the tax-advantaged status of the account.
Conversions from traditional IRAs (or tax-deferred) to Roth IRAs (after-tax) are also exempt from this rule. If you choose to convert some of your pre-tax retirement investment money to post-tax retirement money, that’s a completely separate action independent from any rollover activity.
Read more on Traditional vs. Roth IRAs here.