At Capitalize, we specialize in making rollovers easier to handle. Inevitably, you’re likely to have a lot of questions if you’re thinking of rolling over an old 401(k), so we’ve created a user-friendly guide to answer some of the most commonly asked questions.
What is a rollover IRA?
A rollover IRA is an investment account used to hold funds either from an old 401(k) or another IRA held at a different brokerage firm. Money moved to the new IRA is said to have “rolled over” from its previous account.
In the most common case, rollovers happen because you’ve left a job at which you maintained a 401(k) for any period of time. Rollovers can happen with only a few hundred dollars, and they can happen with amounts up to many hundreds of thousands of dollars and higher.
Rollover IRAs are usually tagged for the “tax-status” of the money at hand; if you’re rolling over a traditional, pre-tax 401(k) from a previous employer, you’ll want a traditional IRA. If, on the other hand, you’re rolling over an after-tax Roth account, you’ll want your rollover IRA to be a Roth IRA as well.
What’s the difference between a rollover IRA and a traditional IRA?
The terms “rollover IRA” and “traditional IRA” are not directly comparable, but they are related. A rollover IRA is an IRA opened to hold money that originated at another institution, like an old 401(k) from a previous job or an IRA held at a different provider. The rollover account acts as a holding space for money that’s been previously invested elsewhere.
The term “traditional IRA” refers to the tax status of the account. Traditional accounts, broadly speaking, are meant to hold pre-tax dollars – money that’s yet to be taxed. When money goes into traditional IRAs, the account holder may be eligible for a tax deduction. It’s possible to hold after-tax money in a traditional IRA, but doing so eliminates much of the tax advantage of the account.
In short, rollover IRAs can be traditional IRAs at the same time, but they don’t have to be. It’s perfectly normal – and common – for a rollover IRA to be a Roth IRA. Remember, though, that if you do attempt to roll an account into a Roth IRA, make sure it’s a Roth account to begin with – or you could be in for an unpleasant surprise come tax time.
What are the advantages of a rollover IRA?
Often, the biggest advantages to rolling over an old 401(k) include reduced costs and an expanded investment menu. Many legacy 401(k) plans come with unnecessarily high expenses and limited investment options, and many people opt to move to a cheaper, more flexible retirement account.
In fact, based on our recent white paper, an individual with a poorly allocated or unnecessarily expensive “forgotten” 401(k) plan can forego up to $700,000 in retirement savings – all through very little fault of their own.
Some people also wish to have a clean break from their former employer, depending on the circumstances in which their employment ended. Others may want the simplicity of having their money held at a single institution, and their old 401(k) represents added complexity in their broader financial plan.
With the advantages in mind, it’s not necessary to roll over your old 401(k) unless you have a good reason for doing so. The great majority of 401(k) plans will allow former employees to hold their 401(k)s open indefinitely, so there isn’t any pressure to move your account immediately unless you make that decision for yourself.
What are the disadvantages of a rollover IRA?
Sometimes a rollover IRA may not be necessary, especially if your old 401(k) is held in a low-cost plan that gives you the investment access you want. If your former plan is sufficient and up to your standards, there isn’t any emergency to roll the account over. Rolling the account over to an IRA does introduce a bit of work that you wouldn’t have to do otherwise.
An unplanned IRA rollover can also result in tax due if you roll your old, traditional 401(k) to a Roth IRA held at an outside institution. If you do this, the entire amount rolled over is considered taxable income in the year of the rollover, so it’s especially important to understand the tax consequences of any potential rollover before you take the leap.
In certain cases, rolling over your 401(k) can cause unnecessary complexity in your financial plan. If you’re uncertain, you have the option of consulting with us at Capitalize, or by reaching out to an independent tax advisor or Certified Financial Planner practitioner who can provide objective advice on your specific scenario.
Does transferring my 401(k) into a rollover IRA count as a contribution?
The short answer to this question is no, your rollover is not the same as a contribution. The rollover process should be seen as completely separate from any IRA contributions, and the two actions should be taken and evaluated independently.
Recall that money rolled over to an IRA from a previous 401(k) or other account is ultimately just an administrative transfer. You’re simply moving money from one institution to another, and getting a new account with a few different rules and likely some additional investment access.
An IRA contribution is an additional deposit to your IRA, above and beyond any amounts rolled over. Your IRA contribution will be subject to a variety of constraints, like your income and age. But your IRA contribution will come from your personal bank or investment account, while your IRA rollover will come from your previous employer’s 401(k) plan or other IRA provider.
How much does it cost to open a rollover IRA?
Opening an IRA for free is possible at most of the online discount brokerages, like Fidelity, Vanguard, or Charles Schwab (this is by no means an exhaustive list, but they tend to be the big players in the space).
If you’re paying an ongoing fee simply to keep an IRA open, it’s likely going to be a few hundred dollars or less per year, and possibly much lower.
Often, the only IRAs that will charge fees beyond de minimis maintenance charges are either crypto IRAs (those that allow you to trade and hold cryptocurrency) or IRAs held at major wirehouse institutions (think UBS or Morgan Stanley) that come with a traditional financial advisor.
You’ll need to determine for yourself if the services provided at any of the more expensive IRA providers are necessary and value-adding, but if you’re of the DIY mindset, opening a no-cost IRA is definitely possible.
How do you choose a rollover IRA?
There are a few different criteria you can use to determine which IRA makes the most sense for you:
- Cost. This is the big factor, though sometimes a paid rollover IRA that affords you specialized advice or increased investment access can make sense for you. Rollover IRAs can be and often are free, so you don’t need to pay for anything you don’t actively want or use.
- Access to certain investments. Some people are completely fine with an index-fund-only approach to IRA investing, while others are interested in cryptocurrency. Regardless of your particular preference, you’ll need to make sure the provider you choose offers the access you want.
- Simplicity. Keeping all of your accounts “under one roof” at a single provider can make your life quite a bit easier, especially when it comes to keeping track of forms around tax time. It’s also psychologically easier to know all of your accounts are in one place.
- Reputation. Many of the major brokerage platforms are completely safe when it comes to the security of your money (specific investments notwithstanding), but some of the newer providers should demonstrate a strong track record for delivering on their promises before they earn your trust.
For more detail, check out our IRA comparison piece.
How do you open a rollover IRA?
Once you’ve decided a rollover IRA is right for you, you can visit the online provider of your choice to open and fund an account. Most websites offer step-by-step guidance through the account opening process, as well as free support and guidance for those new to the experience.
While it may seem daunting, opening a new IRA should take anywhere from 30 minutes to an hour (or less) and can be done paperlessly online. There isn’t a need for complex paperwork to be filled out by hand in a crowded office!
How do you move a 401(k) into a rollover IRA?
The process is fairly simple. First, you’ll need to open a rollover IRA at an outside provider, like any of the ones mentioned earlier in the post. Then, you’ll need to reach out to your previous employer (or your previous employer’s 401(k) plan administrator) who will be responsible for sending the money to the IRA provider you’ve chosen.
The key is to make sure that your old employer initiates what’s called a “direct transfer”, which simply means the money flows from institution to institution, and never actually comes to your possession. If you do receive a check, make sure it’s immediately passed on to your new IRA provider. Failing to deposit the money to the IRA can cause unwanted (and expensive!) tax issues.
For further detail, please see our post on moving old 401(k)s to IRAs.
How do you invest in a rollover IRA?
The act of investing in an IRA is the same as investing in any other brokerage account, but there are important tax features you’ll want to know before you get started.
Traditional IRAs are tax-deferred, which means you can trade as much as you want inside the account, but you’ll be taxed on any amounts withdrawn from the account. Ideally, you’ll withdraw the money in retirement, but for a variety of reasons you may choose to tap the account sooner.
Roth IRAs contain money that’s already been taxed, which means you can trade freely inside the account without any tax consequences. What’s more – you can withdraw money entirely tax-free, subject to a variety of holding period rules.
Your rollover IRA should be invested in accordance with your entire financial picture. In other words, take your rollover IRA as one part of a greater whole, and devise a plan that works with your time horizon, risk tolerance, and goals for the future. If you need help, seek objective, fiduciary advice from an advisor that’s qualified to deliver it.
We realize that the process of opening IRAs and managing large amounts of hard-earned retirement money can feel intimidating. At Capitalize, we’re here to help.
Check out our free resource library for more information, or contact us for additional support.