If you’re retiring or moving to a new job and want to take your employer-sponsored 401(k) balance with you, you’ll need to “roll it over” to another account. You could, of course, choose to cash your savings, but that could potentially trigger a massive tax liability that may erode a significant portion of your retirement nest egg.
Even if you chose not to cash it all in, moving from one retirement plan to another could be risky. If handled incorrectly, what should otherwise be a simple move could cost you thousands of dollars in penalties and taxes.
To help you avoid some of those costly mistakes, we’ll simplify the process of rolling over your 401(k) balance into a traditional IRA account. Our step-by-step guide not only shows you how to make the transfer, but also highlights important considerations.
Regardless of which type of account you use to save for retirement, 401(k), Roth IRA or Traditional IRA, it’s important to understand one simple fact: The sooner you start saving, the earlier you’ll be able to reach your retirement goals.
Learn more about the best time to start saving for retirement.
Why 401k Rollover to a Traditional IRA?
If you’re a member of an employer-sponsored 401(k) plan, there are several good reasons to stick with that plan, especially if the employer offers matching contributions. However, when you leave the job, it might be a good idea to consider taking your money with you, for several reasons:
- Some employers don’t allow ex-employees to remain with the plan.
- Others might charge you extra (as an ex-employee) to maintain and manage your account.
- You may be able to access a better selection of investments elsewhere – like a discount brokerage IRA account.
- Your investment fees might be lower than those of your 401(k) plan.
If you’ve held several jobs over the course of your career and are members of multiple employer-sponsored 401(k) plans, rolling them all over into a single IRA may be a great way to manage your money in one place.
Differences Between 401(k) and Traditional IRA
Both 401(k)s and traditional IRAs are powerful tools. Typically, both vehicles allow you to shelter contributions and earnings from taxes.
However, there are a few notable differences between the two.
401(k) vs. Traditional IRA
|Available only where employers offer them, and open to any employee participant – regardless of income. Self-employed individuals need to set one up themselves to participate||Available to anyone that has earned income|
|Your employer manages and administers the plan||Individual plan holders are responsible for managing and administering their own plans; or they may choose Managed Portfolio options offered by discount brokerages|
|Employer may have matching contribution schemes in place||No matching contributions available, but some institutions, like TD Ameritrade and E-Trade, offer cash and credit incentives when opening a new IRA account|
|Contribution amounts are higher: Contributors below age 50 can save up to $18,500 annually, with an additional $6,000 at age 50 and above||Allowable contribution limits are lower: Current contribution limit set at $5,500 for those under age 50, and $6,500 for those age 50 and above|
|Regardless of income level, contributions are tax-deductible||Contributions are based on Modified Adjustable Gross Income (MAGI) and filing status and are tax deductible|
|Plan holders could take loans against their balances||Typically, contributors can’t take loans against their balances|
|Direct rollovers are not subject to tax. Lump-sum withdrawals are subject to a 20% withholding tax||Distributions after age 59 ½ are subject to federal and state taxes and taxed as ordinary income|
|Early distribution options may be available in case of a “distributable event” or a hardship||Distributions prior to age 59 ½ are subject to early distribution penalties|
|Offers a higher level of creditor protection||Creditor protection levels may vary from state to state but are typically lower than what 401(k) plans offer|
|Employers may pass on management and record-keeping fees to plan holders||You do not pay for managing or administering a no-fee IRA account|
How To Roll Over A 401(k) To A Traditional IRA
If you decide to roll over your 401(k), carefully consider the tax impact of your actions. If you choose to roll it over into a traditional IRA, there is no immediate tax impact – 100% of your 401(k) balance transfers tax-free into your traditional IRA account. A 401(k)-to-Roth IRA rollover, however, will trigger an immediate tax liability.
When rolling over your 401(k) balance into an IRA, there may be a 20% withholding tax applied to that balance. And that will mean only 80% of your balance moves to your new IRA account. Moving less than 100% of your 401(k) means you’ll be subject to tax and may have to pay a 10% penalty on the 20% shortfall unless you make up for the shortfall using non-IRA or other non-pension funds.
Here’s how to ensure a stress-free rollover of your 401(k) into a traditional IRA:
Step 1: Select an IRA Partner Institution
The first step is to decide where you wish to invest the money. Since this will be a long-term partnership likely lasting through your golden years, you must consider several factors, including:
- Ease of transfer: Your new IRA partner institution must make the rollover process simple, easy and transparent.
- Depth and breadth of investment options: Check out the list of investment vehicles offered by the institution. Look for a partner that offers a wide variety of investments, including mutual funds, ETFs, stocks, bonds, foreign investments, options and futures.
- Fees and commissions: These levies can substantially drag down the performance of your IRA investments, especially if you opt for a self-directed account. Higher commissions can even undermine savings from a no or low-fee account.
- Trading platform: Evaluate each partners’ trading platform carefully, before making a rollover decision. User-friendly, helpful tools and analytics and knowledgeable and available help staff are key things to consider.
TD Ameritrade, Ally Invest and E-Trade, all have discount brokerage platforms that support IRA accounts. You can get additional information on the best individual retirement accounts. You can compare them below:
|Broker||Best For||Commissions||Account Minimum||Choose your platform|
Get started securely through Ally Investment's website
1 Minute Review
If investors are on the hunt for a bargain broker, Ally Invest could be the one. With low commissions across the board, Ally Invest (formerly TradeKing) stops potential investors in their tracks with its especially low mutual fund commissions. Commissions on stocks and ETFs are notoriously inexpensive as well, and for more active traders or those with larger account balances, commissions can dip as low as $3.95 per trade.
$3.95 per stock trade for Active Traders at Ally Invest
Get started securely through eTrade's website
1 Minute Review
E-Trade is best known for its user-friendly browser, desktop and mobile trading platforms and its extensive research and educational information. E-Trade may not have the lowest commissions compared to discount online brokers, but customers certainly get their money’s worth from E-Trade’s comprehensive offerings.
60 days of commission-free trades with deposit of $10,000 or more
||$0 $6.95 for OTC Stocks||$0||
Get started securely through TD Ameritrade's website
1 Minute Review
This publicly listed discount broker, which is in existence for over four decades, is service-intensive, offering intuitive and powerful investment tools. Especially, with equity investing, a flat fee is charged, with the firm claiming that it charges no trade minimum, no data fees, and no platform fees. Though it is pricier than many other discount brokers, what tilts the scales in its favor is its well-rounded service offerings and the quality and value it offers its clients.
Trade commission–free for 90 days & get up to $2500
Step 2. Open Your Traditional IRA Account
Once you decide where to roll over your existing 401(k) account, it’s time to execute the transfer. Ideally, you should be able to open an account within a matter of minutes. Most reputable investment institutions allow you to complete the entire process online.
Make sure you specifically request the relevant “rollover” option, as all investment houses also offer “new” account opening procedures online.
Step 3. Fund Your New traditional IRA Account
To complete this step, you’ll need to work closely with the administrator of your old 401(k) account. Alternately, your employer’s HR department might also be able to assist you.
You must make a written request to have your balance transferred to the new IRA account you created in step 2. There may be either paper-based or online forms designated for such transfer requests. You’ll need to fill them out and provide necessary account identification details, both for the existing and the new rollover account.
Typically, you’ll have the following options to fund your new account:
This option, also called a trustee-to-trustee transfer, isn’t strictly a “rollover,” but it is the simplest and most expeditious route to moving money from a 401(k) into an IRA account. Ideally, you should request your 401(k) administrator to do a direct wire transfer of the funds into your new traditional IRA account.
A rollover of your employer-sponsored 401(k) plan happens when the administrator of the plan moves the assets held in the account out of the plan. This can happen either in the form of a cash distribution to you, the plan holder, or in the form of stock certificates that you might receive.
You’ll have 60 days to deposit into your new IRA account. Missing that IRS-specified 60-day deadline means you must report that distribution as your income for the period in which you receive it, which means a massive tax bill. Additionally, if you are under the age of 59 ½, you could be subject to a 10% early withdrawal penalty as well!
A word of caution about outstanding loans against your 401(k) plan: You must repay all such loans in full, before executing the rollover.
Consult the IRS website for more details on the various rollover options discussed here.
Step 4. Create an Investment Portfolio
Money in your new IRA account can then create an investment portfolio that’s right for you. Most investment institutions offer a range of portfolio options, including self-directed or professionally managed portfolios.
Typically, IRA accounts have a much broader selection of investment choices than those offered by 401(k) plans. There may be a catch though: It is possible that some investments, that you really liked in your old 401(k) plan, might not be available to you in your new IRA account.
Learn more about great ways to invest.
Before you decide what to do with your 401(k) account, you need to consider how that decision might impact your retirement plans. Tax implications from a rollover, contribution restrictions, possible withholdings and penalties and investment choices are all elements that should go into making a final decision.
Learn how roll your funds into a Roth IRA instead of a traditional IRA.