By Sam Swenson • Updated May 18, 2023
If you’ve recently left an employer and started a new job, you might wonder if you can merge your old 401(k) with your new one. The good news is, in most cases, this is possible.
But before you make any moves, you’ll want to consider the various consequences of rolling over your account. This article will explore the pros and cons of combining your 401(k) retirement savings plans, the exceptions to consider, and the benefits of considering a rollover to an IRA.
For simplicity, let’s assume you have a pre-tax 401(k) at your former employer and a pre-tax 401(k) at your new employer. Aside from the minimal work required to arrange the transfer, there isn’t much labor required. You’ll wait for the money to arrive in your new employer’s plan and then invest the money according to your broader asset allocation in mutual funds, ETFs, or other assets.
When you move your 401(k) to an IRA (a traditional IRA, in particular), there will be some meaningful changes:
IRAs give you access to the entire investment universe via flexible brokerage accounts. You can open an account and trade at most discount brokerages across the internet at no cost. Many 401(k) plans allow you to invest in a limited pool of mutual funds and possibly company stock, but IRA providers often will enable you to broaden your investment choices.
Many people seem to like the additional freedom you have with an IRA account in that it’s separate from any employment arrangement and under your complete control. This means you can have a tax-advantaged retirement account without any contingency on your employment status.
401(k)s are unique in that if you decide to retire at age 55, you can take distributions from the account penalty-free. Theoretically, you can use your 401(k) as a penalty-free way to bridge the income gap from age 55 to 59.5. This option doesn’t exist with an IRA, and withdrawals at age 55 will be subject to an early withdrawal penalty.
401(k)s, among other ERISA accounts, offer the highest level of creditor protection. IRAs are slightly less protected, only covering you in bankruptcy proceedings (up to certain limits).
If you’re working with a pre-tax (or “tax-deferred”) 401(k) and you merge it with a new 401(k) of the same tax status, there won’t be any tax consequences. When you combine accounts, no income is declared; you’re only changing the custodian for the money.
Taxes become an issue when you mix pre-tax accounts with designated Roth accounts which are “after-tax” accounts (like Roth IRAs or Roth 401(k)s). Any amounts transferred from pre-tax 401(k)s to Roth accounts will be fully taxable at your ordinary income rate, better known as your highest tax rate.
So before you make any transfers from tax-deferred 401(k)s to Roth accounts, be sure you understand how this plays out 一 and what it will cost you 一 when it comes time to file your tax return. Ideally, speak to a tax advisor to understand the implications for your IRS tax withholdings and how such a move will affect your overall annual tax treatment.
Some of the unusual 401(k) exceptions include:
If you change jobs while you still have an outstanding 401(k) loan, you’ll only be able to roll over the net balance, which is your total balance, less any outstanding loans. You’ll also be responsible for repaying the outstanding loan from your previous provider within 60 days. If you fail to do this, the entire loan amount will be considered taxable income and subject to a 10% early withdrawal penalty.
Generally speaking, the best way to complete any rollover is by utilizing a direct rollover. You’ll need to call your previous 401(k) provider, and they’ll coordinate with your new employer to directly transfer your balance between the two institutions tax-free and penalty-free.
An indirect rollover occurs when you, as an individual, withdraw your old 401(k) balance and then assume responsibility for depositing it into your new 401(k) within 60 days. If you don’t re-deposit the money within that time frame, called the 60-day rollover rule, you’ll be liable for ordinary income tax and a 10% early withdrawal penalty if you’re below 59.5.
Indirect rollovers are worth avoiding, especially if you can do a direct rollover between your retirement plan providers.
If you’ve decided to go out on your own after several years of working in formal employment, you should know that you can merge an old 401(k) with a newly-created Solo 401(k). Solo 401(k)s have higher contribution limits than traditional 401(k)s, so they’re worth investigating if you’re now self-employed.
If you need assistance transferring your retirement accounts, Capitalize can be your trusted partner and manage the entire process for you.
Find out how we can help you achieve your financial goals today.