When you change jobs, your old 401(k) is likely the last thing on your mind. That goes doubly when you move for a new job.
But your nest egg represents your future. To make sure it doesn’t get lost in the shuffle, here’s what you need to know about rolling over your 401(k).
What Is a 401(k) Rollover?
Just because you opened a 401(k) with one employer doesn’t mean you have to leave your money there after you leave the company. After all, some people change jobs like you and I change underwear, and if they couldn’t take their money with them they’d have countless retirement accounts to manage.
And probably lose track of and abandon. A 2021 study by the U.S. Treasury and the Federal Reserve Bank of Chicago found that 72-year-old Americans had abandoned $790 million in unclaimed retirement accounts, with a median account balance of $5,400.
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The IRS lets you move your retirement savings from one employer-sponsored account to another, or to your individual retirement account (IRA). Known as a rollover, it’s not limited to 401(k)s either. You can roll over funds from any employer retirement account, from 403(b)s to government Thrift Savings Plans (TSPs).
How 401(k) Rollovers Work
In most cases, you can transfer the funds directly from your old retirement account to your new one. You may even be able to transfer all your investments intact, without liquidating them first. If not, the account administrator can send cash via wire or ACH transfer.
Alternatively, you can cash out all your investments, withdraw the money from your old retirement plan, and deposit it into your IRA or your new employer-sponsored plan. It’s called an indirect rollover, and the plan administrator may withhold 20% of your balance for taxes. You’ll get it back as a tax refund — if you deposit the full amount in your new retirement account.
Beware that if you fail to deposit the funds within 60 days however, the IRS typically hits you with the 10% early withdrawal penalty.
If you sell your positions and transfer or redeposit cash, make sure you reinvest the money based on your target asset allocation.
Pros of Rolling Over a 401(k)
It usually makes sense to roll over your old retirement funds when you change jobs.
Consider these reasons to do so when you bid adieu to an employer.
Consolidate Your Retirement Investments
Look no further than the study above — millions of Americans forget about old retirement accounts. These abandoned funds represent lost money.
Even if you manage to keep track of all your various retirement accounts though, it complicates your finances to have more than one or two retirement accounts. It makes it harder to track your asset allocation, rebalance your investments, and plan your investing strategy as you near retirement.
Choose Your Own Investments
Employer-sponsored retirement accounts are managed by a plan administrator, chosen by your employer. They provide a limited list of available investments, and you can’t draw outside those lines.
By rolling over funds to an IRA however, you can choose among virtually any investment on the planet. That includes alternative investments in a self-directed IRA if you choose, rather than just publicly traded assets like stocks and bonds.
Choose Your Own Brokerage
Not every investment brokerage is created equal. Some still charge commissions on all transactions, others offer fewer options for mutual funds or international investments than others.
For that matter, some offer excellent robo-advisor services to manage your investments on auto-pilot. A few of these services are even free, such as SoFi Invest, Ally Invest, and Charles Schwab. Check out some of the best robo-advisors on the market to simplify your investing as you research IRA accounts.
By rolling over your 401(k) to an IRA, you can invest through any broker you like.
Tied to You, Not Your Employer
Although you technically own the investments in either an IRA or an employer-sponsored account, the latter is tied to your employer.
You have complete control over your IRA however. You manage it through your brokerage account, with no third party administrator or employer involved.
Which means you don’t have to worry about moving the money around every time you change jobs. It stays in your account, under your control, forever.
Cons of Rolling Over a 401(k)
Not everyone should roll over their 401(k).
If any of the following apply to you, think twice before closing out your old employer-sponsored account.
IRAs Make You Wait Longer
If you plan to retire early, it may make more sense to leave your money in a 401(k) or 403(b) than roll it over to an IRA.
You can’t withdraw money penalty-free from an IRA until age 59 ½, while 401(k)s and similar employer-sponsored accounts let you withdraw money starting at 55.
Granted, you can roll money over from an old 401(k) to your new employer’s retirement account — if they offer one. Not all employers do, especially smaller businesses.
Not All 401(k)s Are Created Equal
Even if your new employer does offer a retirement plan, you may not like it.
Perhaps it charges higher fees or it comes with fewer investment options. Or maybe you just don’t like those investment options, regardless of how many there are.
If you don’t want to roll over funds to an IRA because of the later age limit for withdrawals, and you don’t like your new employer’s plan, it may make sense to leave your money invested in your ex-employer’s 401(k).
You Can’t Borrow from an IRA
Although you generally shouldn’t borrow against your 401(k), many plan administrators allow it. They generally allow you to borrow 50% of your account balance, up to a maximum of $50,000.
As short-term loans go, the interest rate and fees usually beat out alternatives like personal loans and credit cards. I’ve known real estate investors to use 401(k) loans to cover their down payment on investment properties, or otherwise use them for better purposes than “I like that suede jacket but can’t afford to buy it with cash.”
Even so, most plan administrators don’t let you borrow against a 401(k) if you no longer work at the company. So if you want the option to borrow, you still have to roll over your funds to a new 401(k) in all likelihood.
Should You Roll Over Your 401(k)?
As you decide what to do with your existing account balance, keep the following scenarios in mind.
When to Keep It With Your Former Employer
If you want to withdraw money before age 59 ½, and your new employer doesn’t offer a retirement account, it makes sense to leave the money in your old account. The same logic applies if you don’t like the fees or investment options your new employer offers.
It’s theoretically possible that you’d rather leave your old 401(k) account open for borrowing. If your old employer’s account lets you borrow against it even after you no longer work there, and you don’t like your new employer’s account, you may want to leave the money be.
But you may not have a choice in the matter. For accounts with balances under $1,000, your ex-employer can liquidate your account and mail you a check. For accounts between $1,000 and $5,000, they can roll the money over to an IRA in your name without your permission.
When to Roll It Over
In most scenarios, it makes sense to roll your money over to either your IRA or your new employer’s retirement plan.
Most people find it easiest to just roll the money over to their IRA. They maintain full control over it, from the brokerage to the investments, with no strings tied to an employer. However, if you plan to withdraw money between age 55 and 59 ½, or if you want the option to borrow against your balance, it makes sense to roll over your funds to your new employer’s plan.
When to Cash Out Your Retirement Plan
If you cash out your old 401(k) without rolling it over to another retirement account, prepare for the wrath of the IRS.
Not only do they tax you on your balance, they also slap you with a 10% early withdrawal penalty if you’re younger than age 55 in the year you leave your job. Yikes.
But if you face a dire emergency and need cash right now, you may be willing to swallow those two bitter pills. Just don’t do this without clear and present danger.
How to Roll Over a 401(k)
The steps to roll over a 401(k) are intentionally easy. But you can run afoul of a few pitfalls, so stick to the paved path.
1. Act Promptly
In most cases, you can digitally transfer all of your investments from your old account to the new one, without having to liquidate them. This preserves your cost basis, avoids commissions or other transaction fees, and avoids the risk of market volatility between selling and rebuying.
But if you sell your investments and withdraw the cash, you have only a 60-day window to redeposit it in a new retirement account. Miss that window, and the IRS treats it like a distribution and rains down the fire and brimstone outlined above.
Watch out for one other pitfall of taking a cash withdrawal as well. Many plan administrators hold 20% of your balance as prepaid taxes to the IRS, leaving you with only 80% of your balance to redeposit in your new retirement account. That leaves you to come up with the remaining 20% out of your own pocket, in order to avoid the IRS treating it like an early distribution.
2. Decide What Type of Account to Roll Over Into
Do you want to roll money over to an IRA or your new employer’s plan?
As mentioned, you may prefer your new employer’s 401(k) account if you want the option to borrow against it, or if you plan on retiring early.
But in most cases, it makes more sense to roll over your account to an IRA.
Traditional IRA or Roth IRA
In today’s world, most self-managed brokerage accounts are free. They don’t charge an annual fee for assets under management, and they don’t charge commissions.
Even when a 401(k) doesn’t charge any obvious fees, they sometimes corral you into mutual funds with high expense ratios. But with your IRA, you can invest in low-cost index funds and exchange-traded funds (ETFs).
Bear in mind that you may want to convert your traditional 401(k) funds to a Roth 401(k) or Roth IRA. It will cost you today, in the form of paying income taxes on your balance. But from here on out, your investments will compound tax-free, and you’ll pay no taxes on withdrawals in retirement.
And if your old account is a Roth 401(k), you definitely want to roll it over to a Roth IRA rather than a traditional IRA or traditional 401(k).
3. Set Up a Bank or Brokerage Account (if Needed)
Captain Obvious here: If you decide to roll your balance over to an IRA, but you don’t already have one, you’ll need to open one.
Check out some of the best places to open an IRA account, and while you’re at it, consider opening a taxable brokerage account as well. Sadly, IRAs come with rather low contribution limits ($6,000 in 2022), whereas you can invest as much as you like in a standard brokerage account.
4. Fill Out the Paperwork
Contact your ex-employer’s 401(k) administrator to ask about the procedure for a direct rollover to your new account. They may refer you to your new account administrator or brokerage to initiate the rollover from their end.
Either way, plan on filling out a few forms including your basic details and Social Security number, and whether you want to liquidate your positions or transfer them as-is.
401(k) Roll Over FAQs
The rules and tax implications of a 401(k) rollover can get thorny.
Avoid the ire of the IRS by understanding the most common prickly questions.
How Long Do You Have to Roll Over a 401(k)?
You can roll over funds from one retirement account to another at any time. That goes for both rolling over funds to a new employer-sponsored account or to an IRA.
However if you cash out all your investments and plan to deposit the cash in your new retirement account, you only have 60 days before the IRS classifies it as an early withdrawal.
Do I Pay Taxes on a 401(k) Rollover?
In most cases, you don’t owe taxes when you roll over 401(k) funds.
Beware of two exceptions however. First, if you roll funds over from a traditional 401(k) to a Roth 401(k) or Roth IRA, then you do owe taxes on the balance.
Second, if you liquidate your positions with the intention to deposit the cash in your new account, you have 60 days before the IRS considers it a distribution, as outlined above.
What Is an Indirect Rollover?
An indirect rollover occurs when you cash out your positions in order to deposit the money manually in your new account. It’s where the 60-day time limit comes into play.
In contrast, a direct rollover occurs when you transfer assets directly from your old account to your new one. It’s also known as a trustee-to-trustee transfer, or an in-kind transfer.
What Is Net Unrealized Appreciation (NUA)?
If your previous employer offered stock options and you bought in for big gains, you have another option worth considering.
Net unrealized appreciation (NUA) is the profit you earned on your company’s stock. For example, if you bought 10 shares for $100 apiece ($1,000 total), and the shares are now worth $500 apiece, you earned $4,000 in NUA on your company’s stock (total current value: $5,000).
When you leave your job, you can opt to transfer that stock to a taxable brokerage account without paying the standard income taxes and 10% early withdrawal penalty on it. Instead, you owe income taxes on your cost basis ($1,000 in the example above), payable this tax year. But you can keep the money invested if you like, and when you sell, you pay the lower capital gains tax rate rather than your ordinary income tax rate on the gains.
Regardless, you don’t pay the 10% early withdrawal penalty to the IRS.
Most people should roll over their former employer’s plan to an IRA under their full control.
Still, there are a few scenarios where it makes sense to roll it over to a new employer plan, and in rare cases, it might make sense to leave it in your old employer’s account.
When in doubt, speak with your accountant or other financial advisor for personalized advice. Whatever you do, avoid cashing out your account as an early distribution, or face Uncle Sam’s wrath in the form of taxes and penalties.