401(k) Rollovers & Rollover IRAs (Updated Review)

Considering a 401(k) rollover?

Whether you’re leaving your job or recently lost it, you have options as to what you want to do with your 401(k).

For most former employees, the best choice is to transfer your 401(k) into an IRA.

In this article, we are going to go over everything you need to know to ensure you make the right decision with your 401(K).

Before we dive into the nitty-gritty, let’s go over the basics.

What is a 401(k)

A 401(k) is a retirement account that is partially funded by employers and employees. This kind of account is established by an employer. 401(k)s are tax-advantaged plans. 

The bottom line is simple, contributions made by the employee lower the amount of income tax that has to be paid that year. The employee still has to pay tax, when they withdraw the funds.  

What is a 401(k) Rollover?

Simply put, a 401(k) rollover is the transfer of a workplace retirement plan to an individual retirement account (IRA) or to another 401(k).

When you switch jobs, 401(k) rollovers can come in handy to ensure your savings go where you want it.

What is an IRA?

An IRA is an Individual retirement account. Similar to a 401(k), an IRA is a retirement account but it is not set up by an employer. An IRA is an individual account set up by the individual.

An IRA is a tax-deferred account and was created to give investors a leg up when saving for retirement.

An IRA is ideal for those looking to save for retirement because your money grows and compounds faster than it would in a regular taxable account. 

What is a Rollover IRA?

A rollover IRA is the transferring of funds from an old retirement account or a 401(k) to an IRA. The benefit of having a rollover IRA is that contributions are tax-deductible and earnings grow tax-free. 

Although earnings grow tax-free, you are required to pay income tax when you withdraw your funds. 

How Can I Rollover My 401(k)?

A 401(k) rollover is pretty straight forward. We broke down what you have to do to rollover your 401(k). 

Make sure you follow the steps, doing this process incorrectly can cost you. 

#1 Choose Which 401(k) Rollover is Right For You?

There are two main accounts that you can move your 401(k):

  1. Rolling over your 401(k) to a different/new 401(k)
  2. Rolling over your 401(k) to an IRA

Let’s look at option one, rolling over your 401(k) to a new 401(k)

Rolling over your 401(k) to a different/new 401(k)

If you’re interested in rolling over your 401(k) chances are you’re working for a new business. In this scenario, you have a few options.

You can leave your 401(k) where it is, but we don’t think that’s the best option. You can also rollover your 401(k) to a new 401(k) if your employer allows it. 

In most cases, rolling over your 401(k) into an IRA is the preferred route. The reason is that an IRA has many more investment options and for the most part lower fees when matched by a 401(k).

Rolling over your 401(k) to an IRA

If you decide to rollover your funds into an IRA, you’ll need to choose which type of IRA account and where.

The most popular IRAs are Traditional IRAs and Roth IRAs. 

    • Traditional IRAs– Your investment is tax deducted up to a certain amount. You deposit pre-taxed cash and subtracted from your taxable income. Traditional; IRAs are tax-deferred meaning you pay tax when you withdraw the funds. 
  • Roth IRA- Roth IRA account is not tax-deferred and you must pay tax now on the amount deposited. 

The main difference between the two is deciding whether to pay income tax now or in the future. If you want to rollover your funds without paying tax now, go for the Traditional IRA. If you rollover your account into a Roth IRA, you are required to pay taxes on that amount.

#2 Open a Rollover IRA Account With The Right Institution

The best way to grow your money is to pick the best investments (easier said than done). Investing in an IRA over a lifetime can add up to hundreds of thousands of dollars.

On the other hand fees and commissions can cost a pretty penny. Choosing the right IRA provider is important for your savings.

Below is a list of our favorite IRA providers. These firms made the cut because of their low fees, wide investment access, and useful resources.

You can take a passive seat or an active seat with your IRA. Your activity will come down to a decision. Do you want a regular online broker or a Robo-advisor?

An online broker offers more of an active investment account. Online brokers offer a wide variety of investment options that you can manage yourself.

Robo advisors on the other hand take the more passive route. A Robo-advisor carefully chooses investments for the investor based on the specific risk tolerance of the account opener.

#3 Direct your 401(k) to a Direct Rollover 

A direct rollover is exactly how it sounds.

It is the transfer of money from one retirement account to the other retirement account.

You must ask your employer for a direct transfer, meaning they will send your 401(k) funds to your new retirement account. 

Almost all IRA providers will help you rollover your 401(k) to a new account. 

Follow the directions of the IRA provider closely to prevent complications. Your 401(k) institution should transfer the funds directly into your IRA.

#4 Pick Your IRA Investments 

The moment your money arrives in your new rollover IRA account, you can begin choosing your investments!

An IRA offers a massive amount of investment options, especially compared to a 401(k). Take your time and choose wisely. If you need assistance, there are plenty of top brokers available to help. 

Benefits of a 401(k) Rollover into an IRA

One of the biggest advantages of rolling over a 401(k) into an IRA is that you have greater flexibility over which investments you choose.

Brokerage accounts give you greater access to investment options. Some of the investment options are ETFs, stocks, bonds, mutual funds, CDs, and more.

You can’t get that kind of flexibility with an employer’s 401(k) plan. If flexibility is important to you, particularly when it comes to controlling your retirement funds, a 401(k) rollover into an IRA is the way to go.

There are many advantages to a 401(k) rollover. If the entire rollover is completed in a single year, there is an IRS provision called the Net Unrealized Appreciation (NUA). If invested properly, the NUA provision can lower your tax rate on company stock.

Although there are many advantages of a 401(k) rollover into an IRA, there are also disadvantages. 

Let’s check them out!

Disadvantages of a 401(k) Rollover into an IRA

Depending on your personal situation, there are some disadvantages to moving your former employer’s 401(k) to another 401(k) plan or IRA. 

For instance, If your 401(k) is managed properly and you have a large array of investment options it might be preferable to keep your current 401(k) instead of rolling it over into a new employer’s 401(k) plan or IRA.

You also miss the opportunity to make early withdrawals if you rollover from a 401(k) into an IRA. 

This falls under the IRS rule of 55. Basically an employee who is fired, quits or goes into retirement between the ages of 55 and 59 ½ can withdraw money out of their 401(k) without being fined

However, this benefit goes away once your funds are rolled over into an IRA.

There is also the protection of ERISA to consider. ERISA stands for Employee Retirement Income Security Act. They are overseen and enforced by the United States Department of Labor. 

In the case of personal bankruptcy, creditors cannot access your 401(k) account. IRAs are not guaranteed the same protections. 

If financial instability is a concern as you close in on your retirement years, it may be preferable to leave your 401(k) plan intact.

So Should I Rollover My 401(k)?

Rolling over a 401(k) into an IRA has some pretty nice advantages. We broke it down to 3 main advantages:

  1. IRAs in general offer a more diverse investment selection than your average 401(k) plan.
  2. The cost of investments depends on your employer’s investment offering, but for the most part, an IRA has cheaper investments. 
  3. Many IRA providers charge no account fees

Why a 401(k) Rollover Isn’t a Good Idea For You

Although a 401(k) rollover into an IRA has benefits, this plan isn’t ideal for everyone. You should restrain from a 401(k) rollover into an IRA if:

  • You need a loan-  You can borrow from your 401(k), something you cannot do with an IRA.
  • You are approaching a personal bankruptcy-  In a 401(k) your money is safe and overall better protected from creditors. 

Tax and Your 401(k)

It is very important to be aware of the tax implications that are connected to your decision. We are going to go over the most frequent moves you can make with your 401(k) and how they affect you from a tax perspective. 

401(k) Rollover to an IRA

There are 2 ways to go about this. A direct rollover or an indirect rollover.

Direct Rollover

As mentioned before, a direct rollover is very straight forward. 

Funds move from one retirement account to the next, directly. This is the more common method to move funds into your new retirement fund. 

The IRS doesn’t consider a direct rollover to be a rollover at all, therefore there are no tax implications.

Indirect Rollover

An indirect rollover is when you transfer money from one retirement fund to the next in an indirect manner. 

For example, your former employer sends you personally the funds from your previous 401(k), then you send those funds to your new IRA.

This isn’t a problem from a tax standpoint, but there is something to be aware of. The IRS gives you 60 days to complete the transfer.

If you are unable to complete the transfer from beginning to end in 60 days, you are required by law to report the transfer as a distribution. You will then have to pay taxes on the distributed amount.

401(k) Rollover to Another 401(k)

If funds are sent straight from your previous 401(k) to your new 401(k) (“aka” direct rollover) there shouldn’t be any tax repercussions at all.

Before money is moved, make sure your new employer’s 401(k) accepts the rollover. That will avoid unnecessary headaches in the future. 

Cashing Out Your 401(k)

Just because you can cash out your 401(k) doesn’t mean you should. In fact, if you withdraw money from your 401(k) before the age of 59 ½, you could be subjected to financial penalties.

From the standpoint of the IRS, cashing out your 401(k) before the age of 59 ½ is an early withdrawal. This means that you will be exposed to a 10% penalty on top of your regular income taxes.

This is probably one of the worst options to choose from. 

How Do I Choose an IRA Rollover Provider?

Before deciding an IRA provider, you’ll need to better understand your style of investing.

Are you interested in choosing your own investments in your IRA or do you want your IRA provider to do it for you?

Choose Your Own Investments 

If you’re interested in choosing your own investments you’ll need a broker that gives you the freedom to choose.

Look out for online brokers that charge low fees, educational resources and research tools.

IRA Provider Chooses Investments For You

There are many IRA providers that offer services to help you manage and choose your investments. 

This is often called a Robo-advisor and they are an excellent option. Most Robo-advisors create a personalized portfolio based on your risk tolerance and how you stand as an investor. 

Robo-advisors offer virtual financial advisors without the high fees of a personal physical advisor.

Below is a quick list of our favorite IRA providers. We chose these IRA providers because of their low fees, large investment selection, and useful resources.

Let’s Pull it All Together

It is important to remember that each rollover is slightly different from the next. For the most part, rollovers don’t cause tax implications, especially if you make a direct rollover.

Make sure you check your 401(k) and all that you have in it before you leave for a new job. Then decide what you would like to do. 

Failure to do so could lead to multiple unorganized retirement accounts and possible tax penalties.