401(k) Rollovers and Rollover IRAs: A Step-by-Step Guide

Key steps include initiating your rollover without incurring taxes and finding the right home for your new IRA.

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If you have a 401(k) some other retirement account from an old job or previous life, you have a few options on what to do with it. For many people, a great choice is a 401(k) rollover or rollover IRA.

What is a 401(k) rollover?

A 401(k) rollover is a way to move money from a workplace retirement plan to an individual retirement account, typically when you switch jobs or retire. You can also roll over a 401(k) into another 401(k).

What is a rollover IRA?

A rollover IRA is a vehicle for transferring money from a 401(k) or other retirement account in an individual retirement account (IRA). One major benefit of a rollover IRA is that it keeps your retirement dollars safe from taxes when the process is done correctly.

How to roll over a 401(k)

Take these four steps to do a 401(k) rollover or rollover IRA without incurring any unpleasant tax surprises.

Step 1. Decide which 401(k) rollover is right for you

Generally, there are two places you could put that old 401(k).

rolling over your 401(k) to a new 401(k)

If your ex-employer lets you, you can leave your 401(k) money where it is. But that isn’t ideal: You’ll no longer have an HR team at your disposal  for questions, and you may pay higher 401(k) fees as an ex-employee. So one option is to roll your money into your current employer’s retirement plan.

But in many cases, rolling a 401(k) into an IRA is the destination of choice. There, you’ll have a wide variety of investment options and lower fees, particularly compared with a 401(k), which can have a short list of investment options and higher administrative fees.

Rolling over your 401(k) to an IRA

Traditional IRAs and Roth IRAs are the most popular types of individual retirement accounts. The main difference between them is their tax treatment.

  • If you do a rollover into a Roth IRA, you’ll owe taxes on the rolled amount.

  • If you want to roll over your funds without incurring taxes, stick with a traditional IRA.

  • If you're doing a rollover from a Roth 401(k), you won't incur taxes when you roll to a Roth IRA.

Step 2. Open a rollover IRA account

Your choice of IRA provider is not the biggest driver of your portfolio’s growth — that's where your investments come in. However, selecting a provider is critical for keeping fees low and gaining access to the right investments and resources you need to manage your savings.

When deciding where to open a rollover IRA, the choice often boils down to two options: an online broker or a robo-advisor.

  • An online broker is a good fit for you if you want to manage your investments yourself. Look for a provider that charges no account fees, offers a wide selection of low-cost investments and has a reputation for good customer service.

  • A robo-advisor makes sense if you want someone to manage your money. A robo-advisor will choose investments and rebalance your portfolio over time — for a fraction of the cost of a human advisor. Read our explainer on what is a robo-advisor to see if it’s the right choice for you.

Here are some of our top picks:

» Check out our complete list of top IRA account providers

Step 3. Ask your 401(k) plan for a direct rollover

These two words — "direct rollover" — are important: They mean that the 401(k) plan will cut a check directly to your new IRA account, not to you personally.

Virtually all IRA providers will help you do this — many have “rollover specialists” on staff — but the basics are simple:

  • Contact your former employer’s plan administrator, complete a few forms, and ask it to send a check or wire for your account balance to your new account provider.

  • The new account provider should give you pretty explicit instructions for how the check or wire should be made out, what information to include — like your new IRA account number — and where it should be sent.

You can opt for an indirect rollover, which essentially means you’re withdrawing the money and moving it to the IRA provider yourself, a process that needs to be completed within 60 days. But this process exposes you to further tax complexities (read more below), which is why we generally recommend a direct rollover.

Step 4. Choose your rollover IRA investments

Once the money lands in your new IRA account, you can get down to the fun part: selecting your investments. If this is your first IRA, you’ll probably be surprised at the vast number of options on your doorstep, especially compared with the measly selection of funds in your 401(k).

  • For most people, the best choice is to select a few low-cost index mutual funds or ETFs, based on the asset allocation — meaning the way you divide your money among stocks, bonds and cash — that makes sense for your age and risk tolerance.

  • If you’re not up for that, there are hands-off options: If you were invested in a target-date fund in your 401(k), you can find a similar (and perhaps less expensive) fund for your IRA at a broker.

  • If you opened your new account at a robo-advisor, that company’s computer algorithms will take care of selecting and rebalancing your investments based on questions you answer about your timeline and stomach for risk. That’s not to say you can turn a blind eye — we’d never recommend that — but there’s something to be said for turning over the bulk of the dirty work to someone else.

For more details on choosing your own investments, see our guide on how to invest in your IRA.

Benefits of a 401(k) rollover or rollover IRA

Doing a 401(k) rollover into an IRA offers some pretty sweet perks, including:

  • A more diverse investment selection than a typical 401(k) plan offers;

  • Cheaper investments (the cost comparison depends on your employer's investment offerings);

  • Cheaper account fees. While some 401(k) plans pass account management fees along to the employees, many IRAs charge no account fees. If you're confused by retirement account fees, this 401(k) fee calculator can help.

Why a 401(k) rollover may not make sense for you

Avoiding a 401(k) rollover and leaving money in a 401(k) has benefits, too:

  • Your 401(k) is better protected from creditors;

  • Generally you can take a loan from a 401(k), which isn't possible with an IRA (though IRAs offer loopholes for early withdrawals).

For more details, see our list of the pros and cons of rolling over your 401(k) to an IRA.

Tax implications of a 401(k) rollover

Just as you have options for what to do with an old 401(k), there are different tax rules for each option.

Cashing out a 401(k)

This is almost certainly the worst option. Not only does cashing out sabotage your retirement, but it comes with some brutal penalties and taxes levied by the IRS. You could pay a 10% early withdrawal fee, plus ordinary income taxes on the amount distributed. That means you might hand over up to 40% of that money right off the top.

Rolling a 401(k) over to an IRA

If you do a direct rollover, you’re good to go. There are typically no taxes to consider until you start withdrawing money in retirement.

With an indirect rollover, usually the check you receive will be for the amount of your 401(k) account minus 20% of the account balance. That 20% is withheld by the plan administrator to pay taxes on your distribution.

But if you’re planning to roll your money into an IRA, you can avoid paying taxes now by taking steps to make sure you get that money back from the IRS. (The exception to this is if you want to open a Roth IRA, which will require taxes paid on the distribution, unless your money was in a Roth 401(k).)

To get your money back, you must deposit into your IRA the complete account balance — including whatever was withheld for taxes — within 60 days from the date you received the distribution.

  • For example, say your total 401(k) account balance was $20,000 and your former employer sends you a check for $16,000 (that’s the full account minus 20%). Assuming you’re not planning to go the Roth route, you'd need to come up with $4,000 so that you can deposit the full $20,000 into your IRA.

  • At tax time, the IRS will see you rolled over the entire retirement account and will refund you the amount that was withheld in taxes. You'd also avoid a 10% penalty, because had you put just the $16,000 into the IRA, the IRS will say you’ve taken an early withdrawal of $4,000 and you’ll owe the early withdrawal penalty on the $4,000 (and, believe it or not, income tax, too).

Rolling a 401(k) over to another 401(k)

Generally, there aren't any tax penalties associated with moving a 401(k) into another 401(k), as long as the money goes straight from the old account to the new account (otherwise, the IRS might construe the move as a withdrawal and sock you with an early withdrawal penalty).

  • Be sure your new employer's 401(k) plan accepts rollovers, and follow their instructions closely.

  • Although this route may help you keep your financial life organized by having fewer accounts to keep track of, make sure your new 401(k) has investment options that are right for you and that you aren't incurring higher account fees.

  • Know the difference between a regular 401(k) and a Roth 401(k).

Leave it all alone

If your ex-employer lets you, you can leave the plan where it is. This isn’t ideal: Although there may be no tax consequence, you won't be able to keep making pre-tax contributions to the plan.

How to choose a rollover IRA provider

If you've decided a rollover IRA is right for you, finding the best account provider starts with knowing your investing style — whether you're a "manage it for me" type or a DIY type.

Rollover IRA accounts for 'manage it for me' investors

If you're not interested in picking individual investments, you’ll need a provider to do that for you.

An automated investment management service, often called a robo-advisor, is a good option. Robo-advisors will build a personalized portfolio using low-cost funds based on your preferences, then regularly rebalance those funds over time to help you stay on track, all for a much lower fee than a conventional investment manager.

Rollover IRA accounts for DIY investors

If you want to build and manage your investment portfolio, you'll want an online broker where you'll be free to buy and sell a variety of low-cost investments.

One thing to keep in mind: If you go with a traditional DIY broker, your choice of provider won't be the biggest driver of a portfolio's growth — the investments you choose will determine that.

» See all of our top picks for the best IRA providers to find one that's right for you

More 401(k) rollover or rollover IRA questions? We have answers

A rollover IRA can be a traditional IRA, with the same withdrawal rules. Or, you can open a rollover IRA that's a Roth - that's what you would do to roll money from a Roth 401(k). You're allowed to roll traditional 401(k) money to a rollover Roth IRA, but then you'd owe income tax on the money you rolled over. The one main difference between a traditional or Roth IRA and a rollover IRA is that you can roll over as much money as you want into the rollover IRA. If you make IRA contributions in addition to your rollover, you're limited to the annual maximum of $6,000 in 2020, or $7,000 if you're age 50 or older. (In 2019, the limits were the same.)

Rollover IRAs are subject to the same withdrawal rules as all IRAs. Unless you have qualifying circumstances, a withdrawal from an IRA before you reach age 59 1/2 is likely to come with income taxes and potentially a 10% penalty from the IRS. Here are the traditional IRA withdrawal rules and the Roth IRA withdrawal rules.

Yes. The only cautions here are 1) contributions to an IRA are limited to $6,000 per year ($7,000 if you're age 50 or older), 2) if you chose a Roth IRA for your rollover, your ability to contribute may be further restricted based on your income, 3) if you mingle IRA contributions with IRA rollover funds in one account, that may make it difficult to move your rollover funds back to a 401(k) if, say, you start a new job with an employer with a stellar 401(k) plan, and 4) your ability to deduct your traditional IRA contributions from your taxes each year may be restricted if you or your spouse has access to a workplace retirement plan and you earn over a certain threshold. See IRA contribution limits for more details.

No. It is considered separately from your annual contribution limit. So you can contribute additional money to your rollover IRA in the year you open it, up to your allowable contribution limit.

No. But again, you'll need to abide by your annual contribution limits for future contributions to your IRA.

Yes. There is no limit to the number of IRAs you can have. However, you may find it easier if you keep your number of IRAs low, as this will make it easier to keep track of your funds and assess things like asset allocation.

Generally, you set up a rollover IRA so that you can move money from a 401(k) without paying income tax when you move the money. (If you were to simply withdraw the money from your 401(k), rather than roll it over, you'd owe income tax and probably an early withdrawal penalty.) A rollover IRA lets you move money out of a 401(k) without sacrificing the benefit of delaying your tax bill until retirement. While 401(k) and rollover IRA accounts have some similarities, they’re also quite different. Both types of accounts offer pre-tax savings: You can put money in before you pay taxes on it and you can delay your income tax payment until you take the money out in retirement. But with a 401(k), your investment choices are dictated by your employer. With an IRA, your investment choices are almost unlimited, because most brokers offer a wide array of investment options. On the other hand, 401(k)s offer a higher annual contribution limit of $19,500 ($26,000 of age 50 or older) in 2020, compared with the IRA contribution limit of $6,000 ($7,000 if 50 or older). (There's no limit on how much you can roll into an IRA from a 401(k).)

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