Here’s Exactly How to Roll Over a 401(k) to an IRA

If you have a 401(k) from a previous job, you may be wondering what to do with the account. Should you take a different approach to managing your 401(k) during a recession, or roll it over after being laid off? This article will discuss the process of rolling over a 401(k) to an IRA, as well as some of the advantages that this could have from a financial standpoint.

There are generally four options for what 401(k) participants can do with their account: leave the money where it is; roll it over into a new employer’s 401(k) plan; roll it over to an individual retirement account (IRA); or cash it out. Although rolling over your 401(k) to an IRA has several benefits that can help you save for retirement, there are a few instances where it might not be the best option.

The basics of rolling over your 401(k) to an IRA

In most cases, when a 401(k) participant changes jobs, the money in their account is rolled over into a new account. When you roll over your 401(k) to an IRA, you typically have two options:

Direct rollover: You can have your 401(k) plan transfer the distribution directly to your IRA. This can be done by an electronic transfer from your old plan provider to your new plan provider, or you may receive a check in the mail that you then need to deposit in your new account.
Indirect rollover: You can have the distribution paid to you, in which case you then need to deposit the distribution into the IRA yourself. This is a less commonly used option and there are some important things to know about it that we’ll discuss shortly.

The most recommended method to convert your 401(k) funds to an IRA is a direct rollover. The specifics of how it operates will differ from one plan provider to the next. To roll over your 401(k), you will need to contact your provider and request the rollover. After you open a new account, they will ask you for information about the account and explain how to transfer your funds. Some internet service providers offer the option to set up your account and make payments online, while others may require you to call them to set up your account.

How Does Rolling Over Your 401(k) Work?

How do you rollover a 401(k) when you leave your job? In order to understand the distinction between a transfer and a rollover, you need to first understand the difference between the two. A transfer is when you move your retirement savings from one account to another, while a rollover is when you take your retirement savings out of one account and put it into another.

A transfer between two retirement accounts is only possible if the accounts are of the same type. For example, if a person moves money from an old 401(k) to a new 401(k), a traditional IRA to another traditional IRA, or from an old Roth IRA to a new Roth IRA, that is considered a transfer. The most direct way to move funds from one tax-advantaged account to another is to do it directly.

A rollover occurs when an individual transfers money from one retirement account to another. This is often done when an individual changes jobs and wants to maintain the same level of investment in their retirement fund. For example: You might rollover a 401(k) to an IRA. You might rollover a 401(k) to an IRA.

Keep in mind that rollover accounts can vary, but they must all be treated the same way for tax purposes. You cannot rollover a tax-deferred traditional 401(k) to a Roth IRA without completing a Roth conversion.

How to roll over your 401(k) to an IRA: step-by-step

If you’re wondering how to go about doing an IRA rollover, here are the basic steps: Here’s what you need to know:

1. Decide on the type of IRA

The first step to rolling over a 401(k) is deciding between a Roth and traditional IRA. Both 401(k)s and IRAs can be good retirement vehicles, but there are some important differences to be aware of when planning your retirement.

The biggest difference between a Roth and traditional IRA is that with a Roth IRA you pay taxes on the money you contribute now, but you can withdraw the money tax-free when you retire. With a traditional IRA, you don’t pay taxes on the money you contribute now, but you will pay taxes on the money you withdraw when you retire. Here’s why:

Contributions to a Roth IRA are made with after-tax dollars. This means you’ve already paid taxes on that money right now and your distributions in retirement will be tax-free.
Contributions to a traditional IRA are made with pre-tax dollars. As a result, contributions to a traditional IRA can be deducted from your taxable income in the year they’re made. But when it comes time to take distributions in retirement, you will have to pay tax on that money.

A Roth IRA might be the better option if you feel your tax bracket will be higher when you’re ready to retire. The inverse is true for a traditional IRA.

The type of IRA you choose will affect how much money you will have available to spend now. If you roll your 401(k) into a Roth IRA, the money in your 401(k) will be taxed. If you wish to move your 401(k) without having to pay taxes immediately, a traditional IRA could be a more favorable option. If you have a Roth 401(k), you can roll it into a Roth IRA without paying taxes.

2. Open your IRA account

The process of opening an IRA account is typically quick and easy. If you want to manage your investment portfolio yourself, online brokers such as TD Ameritrade, Charles Schwab, and Fidelity offer good options. If you want more control over your investments, you’ll have to put in more work. An alternative to hiring an investment broker is to go with a lower-fee option, although this will likely mean forgoing some features and research.

Choose an IRA provider that automates investments if that is what is preferred. Robo-advisors are online platforms that allow you to invest money in a portfolio of stocks and bonds, based on your risk tolerance and goals. Then they create a portfolio for you using algorithms. Companies such as this typically have lower fees for their services than traditional brokerages.

Betterment charges an annual advisory fee of 0.25% and has no minimum balance requirements. Betterment is offering up to one year with no advisory fees when you sign up for an account and roll over your 401(k) within 45 days.

3. Request a rollover from your 401(k)

You can avoid getting tax penalties by rolling your 401(k) into your IRA. Rolling your 401(k) over to an IRA is often the easiest route to take, though you’ll want to check with your current 401(k) plan administrator as to what options are available to you. If you have to take the distribution yourself, you can avoid paying taxes on it by rolling the entire amount into an IRA within 60 days.

4. Choose how to invest the money in your IRA

Once your deposit arrives in your IRA account, you will be able to withdraw it as cash. If you don’t want a financial institution to manage your IRA investments for you, you’ll need to choose how to invest the money yourself.

If you’re not ready to purchase individual stocks, index funds are a great option. A mutual fund or ETF that attempts to track the return of a specific market index, such as the S&P 500, is called an index fund. Passive funds incur lower fees because they are not actively managed.

Benefits of Rolling Over Your 401(k)

If you know how to rollover your 401(k), then you understand the benefits that come with it. The most important thing about doing a rollover is that you remain in control of your retirement funds. This is especially important after you have spent years investing in a 401(k) plan.

Other pros include:

Your investment account costs will likely be lower once you do a rollover, because leaving your savings in your old 401(k) when you’re no longer an employee means you may pay higher account management fees. Fees matter, and can substantially reduce your savings over time.
You may have more investment choices. Typically, when you do a rollover from a 401(k) to an IRA at a new institution, your investment options increase which might improve portfolio returns and could further reduce fees.
If you don’t want a self-directed portfolio, where you choose the investments in your rollover, you may be able to choose a robo-advisor or automated portfolio so there’s less for you to manage.
If you have more than one 401(k) from various jobs, you can consolidate them as part of the rollover process.

Disadvantages of Rolling Over a 401(k)

It’s important to avoid making retirement mistakes, and one of these mistkaes might be rolling over your 401(k).

First, if you have a lot of appreciated company stock, you may be able to pay a lower tax rate on the gains if you transfer the stock to a brokerage account.
While a rollover account at a different institution may provide more investment options, if you keep your 401(k) where it is, you may be able to buy investments at the cheaper institutional rate.
If you do a rollover, you may lose some of the federal legal protections that come with 401(k) plans. For example, the money in your 401(k) is typically protected from creditors or collections, whereas the money in an IRA is shielded by state laws, which can vary.
In some cases, your employer may allow you to withdraw funds from your 401(k) without paying the usual 10% penalty, if you are 55 or older when you leave your job.

When Is a Good Time to Roll Over a 401(k)?

The best time to rollover your 401(k) is when you leave your job. But you can generally do a rollover any time. It’s your money. It’s better to rollover your 401k five years after leaving your job, than never to do it.

If you have a low balance in your 401(k) account, your employer might require you to do a rollover. If your balance is less than $1000, your employer may be able to take the money. Make sure to check in with your employer about the specifics of the situation.

In most cases, you have 60 days to roll over an IRA or 401(k) distribution into a new qualified plan from the date you receive it. If you don’t deposit the money within 60 days, you’ll have to pay taxes on it, and you might also have to pay a penalty. One rollover per year is allowed under the rules.

The Takeaway

Rolling over your 401(k) is not difficult, and it can offer you a number of advantages. If you leave your job, you may lose the benefits and terms that applied to your 401(k). If you move on from your current account, you may have to pay more in fees, and you will likely no longer be able to contribute to that account.

If you’re changing jobs, you may want to consider rolling over your 401(k) to a new employer’s plan or an IRA. Doing so could give you more control over your retirement funds and provide more investment options.

There are some times when you shouldn’t do a rollover, like when you own a lot of your old company’s stock. Be sure to think through your options.

SoFi makes it easy to transfer your 401(k) money to an IRA if you know it is the right thing to do. If you open an investment account with SoFi Invest and set up a traditional or Roth IRA account, you can transfer the funds from your old 401(k) into your new account. You can either keep the same investments, or choose new ones.