401(k) Rollovers

If you are leaving your current employer for any reason other than retirement, there are four options for what to do with the 401(k):

1. Cash out the 401(k)
2. Keep the 401(k)
3. Consolidate the 401(k) with the new employer’s plan
4. Rollover the 401(k) into an IRA

1 – Cash Out Your 401(k)

Cashing out a 401(k) is typically only a good option in emergencies unless you are retiring. A 401(k) is tax-deferred so that money will be taxed when you cash it out at your current income tax rate. In addition, there’s a 10% penalty if you cash out the account when you’re younger than 55 (if you’re not working) or 59½ (if you are working).

Unless you’re short on money, cashing out the 401(k) is generally not the best option for your finances. If you were laid off, for example, and do need the money, it’s best to take out only what you absolutely need. Withdrawing any money from your 401(k) reduces the account’s balance and can therefore affect future earnings.

2 – Keep Your 401(k) Where It Is

Whether or not you should keep the original 401(k) depends on several factors. This, of course, is the easiest option as it usually requires no action on your part. Keeping your 401(k) where it is can also allow you to avoid the IRA aggregation rule if you plan to do a Roth conversion in the future (this also applies to rolling it over to a new 401(k) with a new employer).

The primary disadvantage of keeping your existing 401(k) is that you can’t make any new contributions to it as well as the fact that most 401(k)s offer a limited amount of investment options vs if you were to roll it over to an IRA.

3 & 4 – Rollover Your 401(k)

If you choose to rollover your 401(k) to a different plan, you can do so either to a personal individual retirement account (IRA) or to a 401(k) under the new employer (if the new employer offers a 401(k) that allows a rollover).

By rolling over the account you may be able to continue to make contributions to it. However, there are usually investment options with an IRA that aren’t available with a 401(k). So the more common option when switching jobs is to open an IRA and roll over the old 401(k) to this IRA while starting in the new 401(k) with a new employer if matching or other employer contributions are offered.

An IRA is an Individual Retirement Account. There are four types of IRAs:

• Traditional IRA
• Simple IRA
• Roth IRA
• SEP IRA

IRA accounts are similar to 401(k) accounts in that they’re tax-advantaged and there’s a 10% penalty if you withdraw money from them prior to age 59½. Some types of IRAs may also be subject to your current tax rate if you take money out early as well.

An advantage to having an IRA is that a wide variety of asset types can be included:

• Stocks
• Bonds
• Mutual funds
• ETFs
• Real Estate
• Private Placements
• Tax Liens

The type of IRA available to you depends on your employment status as well as taxable income. If you are opening the account as an individual, you may be able open an IRA: traditional or Roth IRA. If you’re a small business owner or if you’re self-employed, you may be able to open a simple or SEP IRA.

Traditional IRA

Your traditional IRA contributions are typically tax-deductible if you and/or your spouse are not covered by a plan at work. If you and/or your spouse are covered by a plan at work, your deduction is tied to certain income thresholds. Below is a table of the phase-out income ranges for tax deductions – if your income is above the listed ranges, your contribution is not tax deductible.

Filing Status	Phase-Out Range for Tax Deduction
Single or Head of Household	$73,000 – $83,000
Married Filing Jointly or qualifying widow(er)	$116,000 – $136,000
Married Filing Separately	$10,000

When you reach what the government calls “full retirement age,” you’re required to begin taking money out of your traditional IRA. Your “full retirement age” is based on the year you were born, as the table below shows. These deductions are called required minimum distributions (RMDs) and are calculated based on your life expectancy. Even if you’re required to take RMDs, you can still contribute so long as you’re still working. If you don’t take out the required amount, then there could be a tax penalty of up to 50%.

Year Born	RMD Age
June 30, 1949, or earlier	70½
July 1, 1949 – December 31, 1950	72
January 1, 1951 – December 31, 1959	73
January 1, 1960 or later	75

In addition, there are contribution limits for Traditional IRAs. In 2023, the max contribution limits are $6,500 for those under 50 years of age and $7,500 for those over.

Roth IRA

With a Roth IRA, contributions aren’t tax-deductible and there are no RMDs. Another feature is that any monies contributed to a Roth can typically be withdrawn at any time without any taxes or penalties. When you withdraw any gains, however, before age 59½ and do not use it on a qualifying expense, then you may have to pay a 10% penalty.

Yet some types of qualified distributions are tax- and penalty-free:

• Distributions from accounts opened for 5 years or longer as long as you are 59½ or older
• Distributions of contributions only (no gains)
• Distributions for qualifying expenses such as first-time home purchases, college expenses, and birth or adoption expenses.

There is also an income phase-out that determines whether you can contribute up to the maximum amount allowed.

Filing Status	Phase Out Range for Tax Deduction
Single or Head of Household	$138,000 – $153,000
Married Filing Jointly or qualifying widow(er)	$218,000 – $228,000
Married Filing Separately	$10,000

As with the Traditional IRA, the same contribution limits apply.

Self-Directed IRA

A self-directed IRA (whether traditional or Roth) allows you to have more options for what kinds of investments you want to include in your IRA, including tax liens, private placements, and real estate. These are not as common and are only offered by a few institutions as they require more bookkeeping, depending on the types of investments held.

Rolling over your 401(k) is typically the best choice. You avoid the financial penalties of cashing out the 401(k) early and you can possibly still make contributions to it. If you cash out your 401(k) before you turn 55 (if you’re not working) or 59½  (if you are working), there’s a 10% penalty on anything you take out of the account. If you cash out your 401(k) while you’re still working, you’ll be taxed on anything you take out at your current tax rate.

Rolling over your 401(k) is typically the best choice. You avoid the financial penalties of cashing out the 401(k) early and you can possibly still make contributions to it. If you cash out your 401(k) before you turn 55 (if you’re not working) or 59½ (if you are working), there’s a 10% penalty on anything you take out of the account. If you cash out your 401(k) while you’re still working, you’ll be taxed on anything you take out at your current tax rate.

Rolling over the account to either an IRA or a different 401(k) allows you to possibly grow the account via contributions and avoid financial penalties.

A 401(k) rollover is the transfer of money from an existing 401(k) account to another retirement account. What type of retirement plan account the funds roll over into depends on your new job circumstances. If you’re working for a new employer, that employer may offer a 401(k) with competitive investment options. If you’re self-employed or your new employer doesn’t offer a 401(k) retirement plan, then you could choose instead to roll over your funds into an IRA.

There are three types of rollover:

1. Direct rollover
2. Transfer from trustee to trustee
3. Indirect rollover (60-day rollover)

1 – Direct Rollover

A direct rollover is a transfer of funds from one retirement account or plan directly into another account or plan. For example, an investor could transfer funds directly from a 401(k) account to an IRA. A direct transfer of funds doesn’t incur financial penalties and doesn’t create a taxable event.

How Does a Direct Rollover Work?

A direct transfer involves the custodian of the original 401(k) account making a check out to the new account’s custodian, typically not to the account holder. If the account holder does receive the check (made out to the account holder) with the 401(k) funds, those funds must be deposited within 60 days or it will be considered a withdrawal, incurring income taxes on the funds and possibly any applicable financial penalties.

As long as the funds are deposited into the new account within 60 days, the money will not be taxed, unless the account receiving the funds is a Roth IRA. 401(k) accounts and traditional IRAs are not taxed until the money is withdrawn, but with a Roth IRA, the money is taxed as it is deposited rather than upon withdrawal.

2 – Trustee-to-Trustee Rollover

A trustee-to-trustee rollover can only occur between IRA accounts. It’s similar to a direct rollover in that the funds are transferred directly to the new account. The trustee of the original IRA account transfers the funds to the trustee of the new account without going through the account holder.

3 – Indirect Rollover (60 Day Rollover)

An indirect rollover is a 401(k) rollover in which the money is sent to the account holder (check is made out to him/her), who then deposits the funds into the new qualified retirement account. With an indirect rollover, there’s a risk of incurring taxes and penalties on the funds if it’s not transferred properly. Therefore, direct rollovers are typically preferred because the money is transferred from one account to another directly without passing through the account holder first.

In an indirect rollover, the account holder has 60 days to deposit the funds into the new retirement account, whether it’s a new 401(k) or an IRA account, in order to avoid penalties and taxes. If the 60-day deadline is not met, the funds are treated as a withdrawal.

Because money deposited into a 401(k) isn’t taxed until withdrawal, income tax at your current rate would be owed on the total amount of the funds withdrawn. On top of that, if you are under the age of 59½, you could also incur the 10% early withdrawal penalty.

Why Would I Choose the 60-Day Rollover?

To many retirement savers, the 60-day rollover can seem like a ticking clock, an alarm just waiting to go off. Why would someone wait 60 days to roll over the money to the new retirement account with the risk of taxes and a possible penalty hanging over them? The 60-day rollover can work like a 60-day loan from your own retirement account.

A disadvantage of doing this is that when the account administrator writes a check to you for the amount you want to roll over, they have to withhold a percentage of that money for taxes, typically 20%. In order to not pay taxes on the amount that was withheld, you have to pay back the total amount, including what was withheld, even though you never actually received that total amount. While you will eventually get these funds back (20%), it will not happen until you file your taxes in the following year.

Can I Extend the 60 Days Rollover Limit?

The IRS does allow for extensions to the 60-day limit for rollovers, but only if you have missed the deadline due to circumstances outside of your control. For example, if the financial institution managing the new account receives the funds before the end of the 60 days but does not deposit them due to an error on their part, you would qualify for an automatic waiver.

Depending on your employment situation, the choice between rolling over to a new 401(k) and an IRA may be made for you. If you are working for a new company that doesn’t offer a 401(k) retirement plan, an IRA may be your only option. However, if you have the choice, there are advantages to each kind of retirement account. It’s important to consult with your financial advisor to review all your available options before you make a final decision.

401(k) vs. IRA

An IRA is typically more flexible when it comes to the types of investments the account can hold. Most 401(k) plans are limited to a list of predetermined choices when it comes to investment options while many IRAs have no such limitations of choices, asset classes, etc. This could allow for a more comprehensive portfolio allocation and theoretically improve returns in the long term. Of course, rolling over into a new 401 (k) does keep life simpler as there is only one account to track vs two. In addition, one should consider any associated fees with both options.

401(k) and IRA Fees

Retirement accounts of any kind typically have fees. These fees vary depending on the exact account and retirement plan that you have. Because of the investment limitations, an IRA is often a better choice as far as portfolio creation and allocation are concerned. And while there is a debate about paying fees for investments, this should be differentiated from fees you pay a professional to manage the money for you. Considerations in determining if you should pay a professional a fee to manage your portfolio include: 1) constant monitoring of allocation as measured up against risk tolerance and financial goals; 2) monitoring of investment selections; 3) adjustment of portfolio based on ongoing economic and market changes, and 4) your ability to do all of the above from an academic, mechanical and time bandwidth perspective.

401(k) to 401(k) Rollover

If you are working for a company that matches your 401(k) contributions, opening a new 401(k) with the new company might be the best choice. The matching contribution is free money towards your retirement account. Even if there are fees or limitations on what kinds of investments you can have in the account, the additional funding is almost always worth it.

If the new 401(k) account qualifies, it may be possible to roll the funds over from the old employer’s 401(k) into the new employer’s 401(k). You would have to confirm with your human resource department or refer to the “plan documents” to see if the plan allows rollovers into it.

The benefit to rolling over an old 401(k) to a new one is that it keeps tracking your portfolio simple as they are all under one roof.

There are typically investment disadvantages to rolling over the funds from your old 401(k) into an IRA as 401(k) plans are usually limited to a certain set of options while IRAs may have unlimited choices. So, it’s more common to roll over into an IRA instead of to the new 401(k). The new employer contributions won’t affect any pre-existing funds transferred into the account, so many people elect an IRA instead for more control over their investment options with that account. Be sure to discuss your options with your financial advisor before making any decisions.

If your new employer does offer 401(k) contributions, it’s usually a good idea to start a new 401(k) with that employer, regardless of what you decide to do with the old 401(k). The employer contributions are free money for your retirement account.

Traditional IRA vs. Roth IRA

If a 401(k) isn’t an option for you, your choice will be between the two different types of IRA that are available for 401(k) rollover. Here, too, your options may be limited depending on the type of 401(k) that you currently have. If you have a Roth 401(k), you will only be able to roll over your funds into a Roth IRA.

The primary difference between a traditional IRA and a Roth IRA is the taxes. In a traditional IRA, the contributions are typically tax-deductible and the funds in the account are not taxable until they are withdrawn. In a Roth IRA, all contributions are taxable now, but if you maintain the IRA and meet its requirements for at least five years, all funds, including any after-tax contributions and any earnings on those contributions, are all tax-free.

In addition, with a traditional IRA, there are RMDs when you retire. You’re required to withdraw a certain amount of money, whether you need it or not. With a Roth IRA, you can leave the money in the account if you don’t currently need it. You can even leave the funds in a Roth IRA to be inherited by your heirs and they would have ten years per the SECURE Act to withdraw all of the funds from it.

IRA Tax Considerations

When deciding between the two different IRA options, you should look at what your finances are now versus what you believe they will be when you retire. If you are currently in a high tax bracket and will be retiring within five years, a Roth IRA may not be the best option for you. You would be paying more in taxes and wouldn’t reach the five-year limit which would result in tax-free growth on the account.

If you’re currently in a lower tax bracket and anticipate that you’ll be in a higher bracket, later on, a Roth IRA may save you money. Choosing a Roth IRA would mean you would pay the lower tax rate you’re currently paying rather than the higher tax rate at the time you withdraw the funds.

It’s important to speak with your CPA and/or financial advisor first to determine what course of action is best for you from a tax perspective.

There is a limit of one rollover per twelve-month period, but only if you are transferring funds from one IRA to another IRA. That time limit does not apply if you are converting a traditional IRA to a Roth IRA, or if the rollover is trustee-to-trustee. The rule also doesn’t apply if you are rolling over funds from a 401(k) to either another 401(k) or to an IRA.

In order to actually perform a 401(k) rollover, you first need to decide which type of rollover you are going to do. Then, you would need to decide between a direct rollover and an indirect rollover. direct rollover is recommended unless you need to take the funds as a loan from your account. It can cost you a lot of money if you choose an indirect rollover and make any mistakes with the deposit.

Traditional 401(k)

If you don’t need the funds as a temporary loan, a direct rollover is the best choice. You eliminate any risk of an error with the rollover. If you are rolling over from one 401(k) to a new 401(k), you will need to inform the account administrator for the original 401(k) of your intention to roll over the funds. The account administrator will need to know where the new 401(k) account is held so that the funds can be transferred to the new account.

Traditional IRA

If you are rolling over your 401(k) account to an IRA, you first need to choose a financial institution and open the new account. That financial institution can be:

• A bank
• An online investing platform
• A brokerage firm

You’ll need to let the 401(k) account administrator know where you have opened your IRA and any account details they will need to know so that they can send the funds to the new account.

Roth 401(k) Rollover

Some 401(k) plans offer a Roth 401(k) option as well. If you have elected to contribute to a Roth 401(k) you might have monies in two different buckets: your 401(k) and your Roth 401(k). This is because either you contributed to both or because any matching contributions from your employer would have been deposited into a traditional 401(k).

A traditional 401(k) account is pre-tax, while a Roth 401(k) account is after-tax.

Roth 401(k) Rollover Instructions:

If you have funds in a Roth 401(k) (like the scenario described above), it would require that you open both a traditional IRA (to rollover 401(k) funds) and a Roth IRA account (to rollover Roth 401(k) funds) at a financial institution when you effect a rollover. Then, you can follow the same process of instructing the company holding your 401(k) accounts to roll over the funds into your new respective IRA accounts.

The holding company will send a check either to you or directly to the custodian of your new IRA accounts. If you have both a traditional and Roth 401(k) account, there will be two checks. If they’re sent to you, then it will be your responsibility to take them to your custodian for deposit.

As always, if there are any questions, please discuss them with a financial advisor.

Indirect Rollover

An indirect rollover is only recommended if you really need the money. Otherwise, a direct rollover is better. The risk of penalties, taxes, and fees is high if the indirect rollover isn’t done properly. If you do want to do an indirect rollover, inform the account manager of your current 401(k) and they will provide you with a check for the amount in the 401(k) account. You would then have 60 days to deposit it yourself into the new retirement account to avoid incurring penalties and taxes.

When it comes to 401(k) rollovers, it’s important to know which options will be the best for you financially. There are taxes and fees to consider when you are choosing which type of retirement plan you want to roll your 401(k) funds into. Each account type has its pros and cons and while one account type may be ideal for one person, it may not be the best choice for another.

To explore all your options and decide which is in your best financial interest, speak to a financial advisor.