Starting a new job is exciting. Hopefully, you are getting a raise or a promotion — or both. But changes to your employment also come with a lot of paperwork and loose ends. One of those loose ends is the 401(k) from your old job.
Rolling your 401(k) into an IRA is one way to move forward with your wealth-building and retirement plans. However, it’s important to do it right. Luckily, it’s fairly straightforward to roll over a 401(k) to an IRA.
Open an IRA account
Before you roll over a 401(k) to an IRA, you need to have a place to put the assets from your 401(k), said Roger Whitney, a certified financial planner who bills himself as the Retirement Answer Man.[c][d] “Open an IRA with a reputable broker,” he suggested. “It’s pretty easy to do online, and only takes a few minutes.”
Whitney recommended looking at your needs and preferences as you choose you IRA investment broker. For most people, robo-advisors such as Betterment and Wealthfront can serve as good places to keep an IRA. Brokers, including Schwab and TradeKing, also offer IRAs.
Most of these brokers offer basic funds, individual stocks, and ETFs that can be held in your IRA, continued Whitney. If you want to keep precious metals or real estate in your retirement account, you may need to look for an administrator that specializes in self-directed IRAs. For most investors rolling a 401(k) into an IRA, Whitney suggested sticking with the basic brokers and basic assets — stocks and bonds.
Talk to your current 401(k) plan administrator
Once you have opened an IRA brokerage account, it’s time to talk to your current 401(k) plan administrator. Find out what paperwork you need to fill out. For the most part, Whitney said, your current administrator will give you a form. You just need to know the account information for your IRA.
“Ask for a direct rollover,” said Whitney. “Your 401(k) administrator will transfer your assets straight into the IRA without putting it into your hands.”
This is important because things can get ugly if your money comes to you first. Whitney pointed out that most 401(k) administrators automatically withhold 20 percent of your money when it goes to you, with that money earmarked for any taxes or penalties for early withdrawal. If you then put the money in an IRA, you have to fill out more paperwork to get some of that 20 percent back and added to your IRA.
“It’s much easier to talk to your human resources representative or plan administrator, and have them take care of it directly,” said Whitney.
That’s it! Whitney said it’s easy to roll over your 401(k) to an IRA because someone else takes care of it.
When to roll over a 401(k) into an IRA
For the most part, Whitney said, the advantages to rolling a 401(k) into an IRA revolve around choice and control.
“You can choose exactly where you want your money to be,” said Whitney. “With an IRA, you usually have more fund choices, and you can even choose individual stocks. If you go self-directed, you can even get into assets that few administrators will even touch.”
For investors looking for more options — especially when it comes to saving money on fees — an IRA can be an excellent choice. “With an IRA, you can usually find lower management fees, and funds with much lower fees. It’s a money-saver as well as a way to access a wider variety of options,” said Whitney.
However, he also pointed out that it doesn’t make sense in all cases to roll the 401(k) over if you don’t have to.
“Some workplaces and administrators require you to move your assets, or they charge additional fees,” he said. “But there are cases where, if you can keep the money in the old 401(k), it might make sense.”
Some 401(k)s have what are called “stable value funds” that you don’t often get outside a 401(k), said Whitney. “These funds offer a bond-like yield with no interest rate risk,” said Whitney. “For some older investors, this can be an advantage to keeping the money in a 401(k).”
He also said that for some high-earners, liability risk could be an issue. If you’re sued, in some cases the federal government might protect your nest-egg assets from judgment better than state law.
“For asset protection purposes, 401(k)s are governed by federal law,” Whitney continued. “IRAs are governed by state law, which could be different. For doctors or someone else with liability issues, that could make a difference.”
‘Think 3 times’ before cashing out your 401(k)
Whitney said you might be tempted cash out your retirement account, but that comes with taxes and penalties.
“If you are under age 59 and a half, you will have to pay a 10 percent penalty on the money,” Whitney said. “Plus, you also pay taxes on the money at your marginal rate. That can get expensive if you have a sizable balance.”
Even if you aren’t subject to penalties, Whitney recommended thinking three times before cashing out. The taxes could be expensive, and there is the question of lost time in the market. “Even during retirement, you might want some of your money working for you in a tax-advantaged retirement account,” he said.
Should you roll over a 401(k) into a Roth IRA?
Another consideration is rolling a 401(k) into a Roth IRA, in which taxes are taken out now instead of when you withdraw from your account during retirement. “A lot of people like the Roth IRA because later, when you take distributions, you don’t pay taxes,” said Whitney.
However, he warned that if your money has been in a traditional 401(k), there are still tax consequences. Because contributions to your 401(k) have been taken pre-tax, you’ve received a benefit today. Rolling into a Roth IRA means a tax benefit later, so the IRS expects to take its cut of taxes today.
“It can be worth it in some cases to pay the taxes now,” said Whitney. “But depending on the size of the retirement account, it might make more sense just to keep the tax advantages and withdrawal rules similar, and roll a traditional 401(k) into a traditional IRA.”
He recommended speaking with a retirement planning professional or tax professional before deciding to move traditional 401(k) assets into a Roth IRA.
In the end, Whitney recommended sitting down with a knowledgeable professional to look at your options for every side.
“In many cases, you’ll be just fine when you roll over your 401(k) to an IRA,” he said. “But it never hurts to get a professional opinion. The good news is that once you decide to move your assets, it’s as easy as asking someone else to do it for you.”
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