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How to Rollover Your 401(k) to an IRA

Deciding what to do with your 401(k) retirement plan when you leave a job can be intimidating. Unless you have an extreme hardship and need to cash out your 401(k), it’s almost always best to rollover your old retirement plan into a rollover IRA. Once you understand why—and how—to rollover your old 401(k) into an IRA, the process is easy.

What Happens to an Old 401(k)?

If you contributed money to a 401(k) or another employer-sponsored retirement savings account and then leave that employer, you eventually need to decide where to move the money in that account. Usually, there’s no rush—the money is still yours, and it will continue to grow in the investments you previously selected. At some point, however, you’ll want to move the funds in that account into an account that you can control without going through your former employer. When that time comes, you have three options:

  • Cash out the 401(k) account
  • Rollover the old 401(k) into your new employers’ 401(k)
  • Rollover the old 401(k) into an individual retirement account (IRA)

Since 401(k) accounts are designed to provide tax incentives to save for retirement, cashing out is almost always a bad idea. Not only must you pay 20% federal income taxes, state taxes, and a 10% early withdrawal penalty, if you spend that money now rather than leaving it invested, you’ll lose out on decades of compound interest.

The smart choice is to rollover an old 401(k) into either your new employers’ 401(k) (if offered) or an IRA in your own name. When you do a direct rollover (meaning the money from the old account is sent directly to the new account), you do not have to withhold nor pay any taxes on the transaction. And, given the choice between the two, rolling over to a IRA is preferable to rolling over to a new 401(k).

Why Rollover Your 401(k) to an IRA?

The biggest benefit to rolling over your old 401(k) to an IRA rather than a new 401(k) is the control you will have over your investments. Few employer-sponsored retirement plans give you unlimited investment options. In fact, many 401(k)s only provide a handful of mutual funds and other investment options.

With most IRA accounts, you can invest your money in almost anything you want including cash, stocks, mutual funds, index funds, bonds, and more. Even if you’re not interested in actively managing your investments today, you may want that control down the road.

How to Rollover Your 401(k) to an IRA

To rollover your old 401(k) to an IRA, you’ll need to decide where you want to open the new IRA. Good news is, that can be almost anywhere. Nearly every brokerage company and bank accepts IRA deposits of almost any amount (most places waive account minimums for IRA accounts). I recommend going with a company noted for having superior but inexpensive online trading capabilities, meaning you can control your investments anywhere and won’t pay a lot for trading.

Check my top-rated online stock brokers here.

Once you have opened a rollover IRA account at your new broker, contact your former employer and ask for a 401(k) rollover form. (The may also have provided this at your exit interview). Fill it out and include your new brokerages’ information and return it to your old employer. In most cases, they will take care of the rest. In some cases, they may mail you a check for the balance of your old account. The check will be made out to your new brokerage “for benefit of” your name. Mail it off to your new brokerage, and your IRA is funded!

The final step is to select your investments. If you don’t have a personalized investment strategy, your best bet is to stick with low cost index funds that track the overall performance of the stock market.

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

Comments

  1. Hi David, thanks for the insightful article and the rest of your blog. I know many people can benefit as they make these types of investment decisions.

    RolloverUSA.com

  2. julie recor says:

    Thanks for the info; I spoke to my CPA and she had me so confused and a tad upset about this topic. Doing my own investigation and educational process on all of this has been insightful; as well as your 401(k) roll over to IRA segment has brought things to me in a sleeker, grander view.

    Thanks…peace and wealth to you all!!

  3. When rolling over a 401k to an IRA, does the yearly contribution limit come into play? I recently left my employer and plan to roll over the balance (~6000) into a Roth IRA. Will I be able to contribute up to $5000 more this year, or will I have to wait until next year?

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