If you participate in an employer-sponsored retirement plan such as a 401(k), what happens if one day you leave the company for a new job or get laid off? Where does that money go?
- You have four options for your 401(k) plan after you leave a job; you can keep it in the plan, cash it out, roll it over into your new employer's plan, or roll it into an IRA.
- Rollover IRAs function the same as traditional IRAs unless the funds are being rolled over from a Roth 401(k), in which case the rollover account functions like a Roth IRA.
- A rollover IRA prevents early-withdrawal tax penalties while giving you more investment options and lower fees than 401(k) plans.
What You Contribute to a 401(k) Is Yours to Keep
All the money you've contributed to a company retirement plan is still yours. If you were eligible for an employer match, you may also have rights to your employer's contributions, depending on your vesting schedule. A company may require up to five years before granting you complete ownership to its contributions.
Your Employer Retirement Account Options
It can be reassuring to know that you still have access to your contributions and those vested employer-matching contributions. Whenever you terminate employment after participating in a workplace retirement plan, you will have several options for what to do with the vested amount in that account. In fact, there are four options you should consider:
- Cash out of the plan
- Leave the money in the plan
- Roll over into your new employer's qualified plan
- Roll over to an IRA
Cashing out of your former employer's retirement plan is almost never advisable. It is one of the top retirement planning mistakes to avoid. Though leaving your money in your former employer's plan or rolling it over to a new employer plan are both fine options, don't disregard the opportunity to roll your funds into a rollover IRA. A rollover IRA comes with its own set of strategic benefits, and when executed properly, it ensures that you won't trigger any negative tax consequences.
What Is a Rollover IRA?
A rollover IRA is identical to a Traditional IRA—or Roth IRA in the case of rolling over Roth 401(k) funds—except that the source of the money is not annual contributions. Instead, the money that goes into a rollover IRA is money from a previous retirement plan, such as a 401(k) plan. If you do not already have an IRA, you may open one for the purpose of rolling over your 401(k) funds without making any additional annual contributions. On the other hand, if you do have an IRA, you are permitted to roll over your 401(k) into that existing contributory IRA account.
It is important to note, however, that you may not combine traditional IRA and 401(k) funds with Roth IRA and Roth 401(k) funds.
Benefits of Rollover IRAs
Many people overlook their rollover IRA option, because they are just as happy continuing to keep their retirement funds in some form of employer plan. There are a few compelling reasons to opt for the rollover IRA:
IRA Rollover Benefit 1: Continued Tax Deferral
One big advantage of an IRA rollover is the continuation of the tax-deferred treatment you had at your workplace retirement account. What's more, no tax is owed on a properly executed rollover, although it is a reportable transaction to the IRS.
IRA Rollover Benefit 2: Increased Investment Options
Within a 401(k) plan, your investment options are limited to the choices provided to you by your plan custodian and employer. Often, these choices are sufficient, but rarely are they extensive. With a rollover IRA, you can choose to put your money in virtually any mainstream investment imaginable.
IRA Rollover Benefit 3: Lower Fees
In addition to limited investment options, some employer-sponsored 401(k) plans have high administrative fees. These fees are not enough to make contributing to the plan a bad deal, but it makes more sense to keep those retirement assets growing in a similarly tax-advantaged option. IRAs tend to have lower fees, if any, depending on where and how you open the account—say, a banking institution or online bank, or through a financial advisor.
IRA Rollover Benefit 4: Simplification
Instead of juggling a number of former workplace retirement accounts as you switch jobs over the course your career, consistently rolling over your plans to a single rollover IRA reduces complexity. You can look at one account statement and see the balance, recent performance, and investment selections of most of your retirement savings from one account.