Defining Terms: Whats A 401
A 401 plan is a tax-advantaged retirement account typically sponsored by an employer.
The traditional form of the 401 works much like a traditional IRA: Your contributions in a given year reduce taxable income for that year. In a simplified example, if you earn $75,000 and contribute $10,000, your earnings fall to $65,000, saving you tax dollars up front. Your withdrawals will eventually be taxed, though.
401s differ in a few meaningful ways from IRAs:
- Contribution limits: 401s have much higher contribution limits. These typically change annually, but generally you can contribute about three times as much money to a 401 as an IRA.
- Investment options: 401s typically provide limited investment options, with most offering a dozen or fewer mutual funds. In IRAs opened at brokerages, you can invest in virtually any stock exchange-traded fund , or mutual funds.
- Matching funds: Many employers match employee 401 contributions up to a certain percentage of pay.
When Changing Jobs Is This Your Best Option
When an employee leaves a job due to retirement or termination, the question about whether to roll over a 401 or other employer-sponsored plan quickly follows. A 401 plan can be left with the original plan sponsor, rolled over into a traditional or Roth IRA, distributed as a lump-sum cash payment, or transferred to the new employers 401 plan.
Each option for an old 401 has advantages and disadvantages, and there is not a single selection that works best for all employees. However, if an employee is considering the option of transferring an old 401 plan into a new employer’s 401, certain steps are necessary.
Traditional Vs Roth: Which Type Of Ira Should I Roll My 401 Into
Now, the type of rollover IRA you transfer your money into depends on what type of 401 youre rolling over.
If you had a traditional 401, you can transfer the money into a traditional IRA without having to pay any taxes on it . Likewise, if you had a Roth 401, you could roll the money into a Roth IRA completely tax-free. Easy, right? Traditional to traditional, tax-free. Roth to Roth, also tax-free.
You May Like: How To Check Your 401k Account
I Still Have A 401k From My Last Job What Do I Do About That
As you move ahead from job to job, dont make the mistake of leaving a trail of old savings accounts behind you. Put your hard-earned savings to work for you by looking at all the options. If youve left a job and a 401k, here are the options available to you for those funds.
- Leave your balance
- Rollover to new 401 plan.
- Rollover to an IRA.
- Cash out your 401.
How To Roll Over Your 401 To Your New Employer
Rollovers arent always the easiest things to accomplish which is why so many accounts are left behind. To properly complete a rollover, follow these steps:
Once the rollover is complete, it becomes part of your new 401 balance, and you can manage it and invest it as one account.
You May Like: Where Do You Check Your 401k
Changing Jobs Dont Forget To Transfer Your 401k Retirement Account From One Company To Another
Founder and President of Hudson Companies, Financial Planner and SEC Registered Investment Advisor
Employees often make the mistake and dont transfer their old 401k retirement account from one company to another when changing jobs. While its perfectly legal to do this, there are financial advantages when you move your 401k to another company. An old retirement account can be transferred to an IRA or a new employers retirement plan.
Here are five reasons why you should consider taking the route of transferring your 401k rather than leaving your old retirement account behind.
Can I Bring My 401 Funds To The Plan At My New Job
Yes. You can transfer your current assets from your old 401 plan or your transitional IRA without having any tax consequences, provided the new employers plan allows for rollovers. This is called a direct rollover. Its another way to continue enjoying the benefits and ease of a 401 plan. Consider these pros and cons of transferring these assets to your new employers plan:
Dont Miss: How To Save For Retirement Without A 401k
Don’t Miss: How To Access Your 401k Money
How Much Does It Cost To Roll Over A 401 To An Ira
If you do the process correctly, there should be few or no costs associated with rolling over a 401 to an IRA. Some 401 administrators may charge a transfer fee or an account closure fee, which is usually under $100.
Because moving your money from a 401 to an IRA allows you to avoid the 10% early withdrawal penalty that results if you withdraw money from a 401 before 59 1/2, its a far better option if you cant keep your money invested in an old employers plan or move it to a 401 at your new company.
You should consider whether rolling over a 401 to an IRA is a better option than either leaving it invested when you leave your job or moving the money to your new employers retirement plan. If you can avoid 401 management fees and gain access to investments with lower expense ratios, an IRA may be a cheaper account option.
Reasons To Avoid A 401 Rollover
There are some cases when it doesnt make sense to roll your 401 into another account:
IRAs are less protected. If you end up declaring bankruptcy later, a 401 offers more protection from creditors than an IRA.
Higher fees. Depending on the situation you could end up with higher fees when you roll an old 401 into a new 401. Check the fees associated with the new account before you move your money.
Limited investment choices. A new employers 401 might have more limited investment choices. If thats the case, you might want to stick with your existing 401 because the assets work better for your situation.
A 401 gives you access to the rule of 55. With a 401, you might be able to begin taking withdrawals from your account penalty-free before age 59 ½ if you leave your employer after age 55. While IRAs dont have this feature, you may be able to emulate it by taking subsequently equal periodic payments from your IRA.
Read Also: How To Check My 401k Balance
Do I Have To Pay Taxes When I Roll Over A 401
It depends on whether or not youre changing account types with the rollover. For example, if you move funds from a traditional 401 to a Roth IRAthats called a Roth conversionthen you will owe taxes on the money after the transfer. And that could create a hefty tax bill!
But if youre transferring money from a traditional 401 to a traditional IRA, then you wont owe any taxes on that rollover. The same goes for a rollover from a Roth 401 to a Roth IRA .
If you have questions about whether your 401 rollover counts as a taxable event,get in touch with a tax advisor.
When Does A Roth Conversion Make Sense
A Roth conversion, which happens when you roll over money from a traditional 401 into a Roth IRA, comes with good news and bad news.
The good news is that from now on, that money will grow inside your Roth IRA tax-free and you wont pay any taxes on that money when youre ready to withdraw from the account in retirement.
But when you transfer that pretax money from your traditional 401 into a Roth IRA, which is funded with after-tax dollars, youll have to pay taxes on that money now. Thats the bad news.
A Roth conversion might feel like ripping off a Band-Aid now, but itll feel great once you retire. You might want to seriously consider a Roth conversion only if you can afford to pay the tax bill with cash you have saved up. But be careful, because a conversion could add thousands of dollars to your tax bill. If thats just too much for you to stomach, then stick with a traditional IRA rollover.
Don’t Miss: Can A Self Employed Person Open A 401k
Option : Transfer The Money From Your Old 401 Plan Into Your New Employers Plan
Moving your old 401 into your new employers qualified retirement plan is also an option when you change jobs. The new plan may have lower fees or investment options that better support your financial goals. Rolling over your old 401 into your new companys plan can also make it easier to track your retirement savings, since youll have everything in one place. Its worthwhile to talk with an Ameriprise advisor who will compare the investments and features of both plans.
Some things to think about if youre considering rolling over a 401 into a new employers plan:
How Do You Transfer Your 401 To A New Job
Transferring your 401 to a new job means combining two accounts into a single 401. An important step to remember is to check with your new 401 provider to ensure that they accept 401 roll-ins. This means you can transfer outside 401 plans into the new one. Most plans do allow this, but its best to check first to make sure.
Then, youll need to set up your 401 plan at your new job. Once youve established a new 401 account at your new employer, youll need to follow a few steps to transfer the money via a direct or indirect rollover.
Read Also: How Do I Get Into My 401k
Option : Cash Out Your 401
Lets get this out of the waythis is the worst thing you can do with your old 401.
If you withdraw the money from your 401 plan and take a direct cash distribution, youll have to pay any state and federal income taxes you owe on every last penny. And if youre under 59 1/2 years old, you can go ahead and add another 10% early withdrawal penalty to your tab.
But the worst part is youre robbing yourself of the chance to continue earning tax-free or tax-deferred growth on your investments for years, maybe decades. Its just a bad idea all around, folks.
And How Do Taxes Work With An Ira
That depends. With a Roth IRA, youll pay taxes on the money when you contribute, not when you withdraw. In other words: Youll pay the taxes now, rather than later. Which is a benefit if you anticipate being in a higher tax bracket when you make a withdrawal.
If you go with a traditional IRA, expect taxes to work the same as with your traditional 401. Youll make pre-tax contributions, and youll be taxed when you make any withdrawals.
Read the fine print for your traditional 401 plan if you prefer the Roth IRA option. Some plans only allow a 401 rollover into a traditional IRA. Which means youd have to switch to a Roth IRA after the rollover and pay all the necessary taxes.
Read Also: What’s The Best 401k Investments
Option : Leave Money In Your Old 401
Leaving money in your prior employer 401 is the easiest option, at least upfront. You simply leave the money where it is no paperwork and no tax reporting required. However, while easier upfront, you should consider both the short-term and long-term impact on your investments and your overall plan.
Rolling Your Old 401 Over To A New Employer
To keep your money in one place, you may want to transfer assets from your old 401 to your new employers 401 plan. Doing this will make it easier to see how your assets are performing and make it easier to communicate with your employer about your retirement account.
To roll over from one 401 to another, contact the plan administrator at your old job and ask them if they can do a direct rollover. These two words “direct rollover” are important: They mean the 401 plan cuts a check directly to your new 401 account, not to you personally.
Generally, there aren’t any tax penalties associated with a 401 rollover, as long as the money goes straight from the old account to the new account.
Although this route may help you stay organized with fewer accounts to keep track of, make sure your new 401 has investment options that are right for you and that you aren’t incurring higher account fees.
You May Like: What To Ask 401k Advisor
Open Your Account And Find Out How To Conduct A Rollover
After youve found a brokerage or robo-advisor that meets your needs, open your IRA account. Once its open, you can begin the process for rolling over your 401 money into the account.
Each brokerage and robo-advisor has its own process for conducting a rollover, so youll need to contact the institution for your new account to see exactly whats needed. Youll want to follow their procedures exactly. If youre rolling over money into your current 401, contact your new plan administrator for instructions on what to do.
For example, if the 401 company is sending a check, your IRA institution may request that the check be written in a certain way and they might require that the check contains your IRA account number on it.
Again, follow your institutions instructions carefully to avoid complications.
How Do I Complete A Rollover
Read Also: Can I Rollover My 401k To An Annuity
You May Like: Should I Borrow From My 401k
Rolling 401 Assets Into An Ira
When you retire or leave your job for any reason, you have the right to roll over your 401 assets to an IRA. You have a number of direct rollover options:
Rolling your traditional 401 to a traditional IRA. You can roll your traditional 401 assets into a new or existing traditional IRA. To initiate the rollover, you complete the forms required by both the IRA provider you choose and your 401 plan administrator. The money is moved directly, either electronically or by check. No taxes are due on the assets you move, and any new earnings accumulate tax deferred.
Rolling your Roth 401 to a Roth IRA. You can roll your Roth 401 assets into a new or existing Roth IRA with a custodian of your choice. You complete the forms required by the IRA provider and your 401 plan administrator, and the money is moved directly either electronically or by check. No taxes are due when the money is moved and any new earnings accumulate tax deferred. Earnings are eligible for tax-free withdrawal once the IRA has been open at least five years and you are at least 59½.
Rolling your traditional 401 to a Roth IRA. If your traditional 401 plan permits direct rollovers to a Roth IRA, you can roll over assets in your traditional 401 to a new or existing Roth IRA. Keep in mind youll have to pay taxes on the rollover amount you convert.
What Kind Of Plan Is It And Have You Already Started Withdrawing From It
If the client has already started withdrawing from the plan, she cannot transfer it into an RRSP, says Power. She adds 401s that have been rolled over into annuities cannot be transferred.
There are considerations for each plan. For 401s, only the employee-contributed amounts can be transferred to an RRSP without using up RRSP room. Any employer contributions can still be transferred, but the client needs commensurate RRSP room. To get around that, We always recommend converting from a 401 to an IRA first, says Altro. Thats not a taxable event, he adds, and it allows both portions to be transferred to an RRSP without using up contribution room.
Another reason to convert is if a client was a Canadian resident while she participated in the 401 planfor instance, a cross-border commuter, says Wong. Thats because shes ineligible for a direct 401 to RRSP transfer.
For IRA-to-RRSP transfers, Wong says that the transferred value cannot include amounts contributed from someone other than the taxpayer or taxpayers spouse, such as employer pension amounts.
With 401s, the employer plan administrator is responsible for keeping track of the after-tax and pre-tax contributions. With IRAs s are rolled over to IRAs), that tracking responsibility shifts to the individual, says Altro. Advisors must ask clients if they have any after-tax contributions in their U.S. plans.
Read Also: How To Get Into Your 401k
