If you’re lucky enough to have had a 401(k) with an employer you no longer work for, don’t let that money collect dust in what amounts to a dormant account.
Instead, roll 401(k) funds into a retirement account you can actively contribute to.
Why You Need to Rollover Old Retirement Accounts
It’s important to roll over an old retirement account, particularly an old employer’s plan when it's dormant and you’re no longer actively contributing to it. This is why rollover IRAs exist. Designed to receive the transfer of other retirement plan moneys, rollover IRAs allow investors to maintain the tax advantages associated with 401(k)s and other tax-deferred retirement accounts. A rollover IRA also gives you greater control over and a much wider range of investment options.
Action to Take: Rollover Old Retirement Accounts
If you transfer an old 401(k) to a rollover IRA, you don’t want to have to worry about paying taxes or penalties on the transaction, which means you need to be careful about how you perform the transfer.
With a direct rollover, the plan administrator sends funds directly to the new IRA account or may send you a check payable to the trustee of the new account. Because the funds aren’t distributed to you, the Internal Revenue Service (IRS) doesn’t consider it a taxable event.
You might consider converting your old 401(k) into a Roth IRA. You’ll pay taxes on a Roth conversion, but the account will grow tax-free from that point forward—and unlike a traditional IRA, you won’t have to pay tax on withdrawals in retirement.
If you take a distribution from the old plan (withdraw funds), you still have 60 days to roll the money over to avoid paying taxes on the distribution. With an indirect rollover, your employer may withhold 20% of the value of your plan for federal income tax. But if you move the funds into a rollover IRA within 60 days, plus the amount withheld, the IRS refunds the 20% as a tax credit when you file your tax return. But this could be a problem if you can’t easily come up with the 20% amount withheld out of pocket.
Transfer to Your New Employer’s Plan
If you have a new employer who offers a 401(k) plan, you may be able to transfer old 401(k) money there. Before you do this, be sure that investment options are broad enough to meet your needs, and compare plan fees to those you’d pay in a rollover IRA. Also realize that any moves you want to make with your new plan will have to go through the plan administrator first—whereas with your own IRA, you’re effectively that administrator.
Keep Your Old Plan
You have the option of keeping retirement plan money with your old employer, which may be a good idea if you’re happy with the fee structure or investment options, or if you want to transfer it to a new employer’s plan later. You may also have to wait to move money into your new employer’s retirement account until the enrollment period begins or you’ve been on the job for a year.
The IRS does note that if your 401(k) is worth less than $5,000, your old employer might require you to move the money.
Let’s run through a common situation. If you have a 401(k) with a former employer, here’s how to roll those funds into an IRA:
- Contact the 401(k) plan administrator: Tell them you’re rolling your funds into an IRA and ask what information they need.
- Open an IRA account to receive the rollover, or if you’re rolling into an existing account, check that it’s eligible to receive retirement plan assets.
- Request your 401(k) plan administrator execute a direct rollover to the new account.
- If the 401(k) plan administrator already cut you a check, deposit it plus any amount withheld within 60 days.
- Select appropriate investments inside your rollover IRA account.
If you have more than one IRA account, you may be able to consolidate multiple IRAs into a single IRA with a trustee-to-trustee transfer.
Next Steps and More Resources
The process of initiating a transfer from an old retirement account into a new rollover IRA can feel daunting. However, it’s common practice and typically straightforward as long as you understand the difference between a direct and indirect transfer, and pay attention to IRS rules to avoid taxation.
Speaking of taxation, get a head start and finish your taxes early this season by reading the next article in this series.