What is a 401(k) rollover? A how-to guide for changing jobs.

Ravi Kurani
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Changing jobs can be a hassle. Here’s how to keep your retirement fund safe & growing.

Everyone knows what a hassle it is to change jobs.

New coworkers. New boss. New computers & tech. New insurance.

And then there’s the big question: what the heck are you supposed to do with your 401(k) plan?

There are a lot of options at your disposal, and not all of them are created equal.

In most cases, your best bet will probably be to do a 401(k) rollover to an IRA (individual retirement account).

Let’s walk through exactly what that means, and whether a 401(k) rollover is a good idea.

What can you do with your 401(k)?

When you invest in a 401(k) plan, that money is yours. Just because you leave a job doesn’t mean you give that money up—your plan moves with you.

As to how that happens, well…it’s complicated.

There are a number of options you can choose from. By law, your employer is required to give you at least 30 days to decide on one of the following:

  • Leave the money in your former employer’s plan
  • Roll over the money to your new employer if their plan accepts transfers
  • Roll over the money to an IRA
  • Withdraw the money from your account (note: you’ll incur a 10% penalty in this case)

Each of these has its own pros and cons. However, in most cases, doing a 401(k) rollover to an IRA is probably your best option.

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5 reasons to do a 401(k) rollover

In terms of the options available to you, a 401(k) rollover is often the best choice, as it enables you to “pick up where you left off” with your investing. Here are some of the top five reasons why this should be your approach.

1. More investment choices

In most cases, an IRA will have more investment opportunities than an employer-sponsored 401(k) plan. These can include not only mutual funds, but individual stocks, bonds, and exchange-traded funds. You can also rebalance your portfolio anytime you want, versus a 401(k) plan that limits the number of changes you can implement each year.

2. Better communication

It’s harder to maintain communication with your plan administrator when you no longer work for the company. Switching over to an investment management firm can ensure that you receive high-quality service and communication.

3. Lower fees and costs

401(k) plans can be known for their high management and administrative fees that eat into your investment returns. While the employer match usually compensates for this, once you leave the company you’re no longer receiving that match. Of course, IRAs have their own fees, but they’re usually lower, and you have a bigger say over where and how you invest your money.

4. Fewer (and clearer) rules

Since employers have a lot of leeway in how they set up their plans, it’s difficult to get full transparency into your 401(k) rules. However, IRA regulations are standardized by the IRS, making it easier to understand the entire process.

5. Estate planning advantages.

In the event of your untimely (or timely) demise, your 401(k) will likely be paid in one lump sum to your beneficiary, causing tax headaches. An IRA, on the other hand, has more payout options, so you can choose the more advantageous option to them.

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How to rollover your 401(k) to an IRA

The easiest and safest way to rollover your 401(k) is to do a direct rollover from the financial institution that manages your 401(k) plan to the one that will be holding the new IRA.

You could take a riskier option and have the check made out to you, but you have only 60 days to roll it over before the distribution is treated as a withdrawal and taxes and penalties kick in. Additionally, your employer will take out 20% of the balance for tax purposes.

Generally, you have three direct rollover options at your disposal:

  • Rolling your traditional 401(k) to a traditional IRA. The money is moved directly, and there are no taxes due on the assets you move.
  • Rolling your Roth 401(k) to a Roth IRA. Just like with your traditional 401(k), you can roll your Roth 401(k) to a Roth IRA. All new earnings accumulate tax-free.
  • Rolling your traditional 401(k) to a Roth IRA. Only if your plan permits it, you can rollover your traditional 401(k) into a Roth IRA—however, you will have to pay taxes on the amount you convert (but then that money will grow tax-free).

Once the rollover is complete, you can continue treating your 401(k) just like you’ve always done: keep investing and build up that asset for your financial future.

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