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What’s a 401(k) Rollover and How Does It Work?

By Ellevest Team

So … that job’s history. But that 401(k) from your old employer is still your money. Choose your own adventure time: What are you going to do with it?

What’s a 401(k) Rollover and How Does It Work?

You could leave it where it is, but you won’t be able to contribute any more to it after you’ve left. If you change jobs a lot, that’s a lot of old accounts to keep track of. And while many employers pay at least part of your 401(k) plan’s administration fees, there’s no guarantee they’ll keep doing that if you leave.

(That being said, there are some situations where leaving it where it is might make sense. For example, some really big companies provide investment options with super-low fees that you wouldn’t have access to elsewhere. In that case, definitely crunch the numbers before deciding to move your money.)

You could also cash it out, but wait — do not pass go, do not collect any of those dollars. This option comes with massive tax penalties. Like potentially over-50%-of-the-balance-in-your-account massive.

If you’ve decided that neither of those options is right for you, that leaves a 401(k) rollover.

What’s a 401(k) rollover?

Rolling over a 401(k) means transferring the money to another tax-advantaged retirement account. This could include many different types, but the two most common examples are your new employer’s 401(k) (if their plan allows it) or an individual retirement account (IRA).

So … should I roll my money into a 401(k) or an IRA?

Quick refresher: A 401(k) is an employer-sponsored, tax-advantaged retirement plan with a 2019 annual contribution limit of $19,000 ($25,000 if you’re over 50). An IRA isn’t connected to your employer, but it also has tax advantages (especially if your income is under the max for deductions). The IRA annual contribution limit is $6,000 ($7,000 if you’re over 50).

The decision about whether you should put new contributions into a 401(k) or IRA usually comes down to how those contributions will be taxed. But with rollovers, it’s more about investment options and fees — and having all your stuff in one place. Regardless of whether you roll over into an IRA or a 401(k) (or keep your old 401(k), for that matter), you still get to keep all your money (assuming it’s completed in 60 days — more below), and that money gets to keep growing in a tax-advantaged way. More good news: Rollovers don’t count toward the contribution limits mentioned above.

There are upsides to both options, depending on things like when you expect to withdraw the money and what kind of investment options and fees come with your 401(k).

What to Do With Your Old 401(k)

Reasons to roll your money into an IRA

When you have a lot of retirement accounts in a lot of different places, it’s hard to a) wrap your mind around where you actually stand and b) make sure that everything you own is properly diversified. If you have all your retirement accounts in an IRA, on the other hand, balancing your investments — and forecasting whether you’re on track to hit your goals, like we do for you at Ellevest — is a lot easier.

Another big reason why many people choose to roll an old 401(k) into an IRA is to have more choice. When you can decide for yourself which company you’ll open your IRA with (and maybe pick from a wider range of investments), you often have greater control over things like how much you pay in fees and the types of businesses your money is supporting. With a 401(k), you’re stuck with whatever investment provider and investment options your employer picks for you (and the fees that go with them).

Also, if you’re trying to make certain special purchases, the government lets you take money out of an IRA before retirement without facing the 10% early withdrawal penalty. These include things like college costs and your first home. Not so with a 401(k).

Reasons to keep your money in a 401(k) (old or new)

Money in a 401(k) is typically protected from creditors, bankruptcy proceedings, and civil lawsuits, whereas IRAs have more limited protections. Also, you can sometimes take out loans against your 401(k) (although caution: If you leave your job with an outstanding loan, you’ll usually have to pay the whole thing back at once or pay big penalties and taxes) ... but there’s no such thing as IRA loan.

401(k)s and traditional IRAs both make you take required minimum distributions (RMDs) at age 70½, or you’ll face penalties. With a 401(k), though, you can push off your RMDs if you’re still working. Also, you can start withdrawing your money from a 401(k) as early as age 55 if you retire from the same company that provides that 401(k). Roth IRAs, on the other hand, don’t have RMDs, and contributions can be withdrawn at any age without taxes or penalties.

What are the rules?

No matter where your rollover is destined to land, there are some rules you should know going in.

The 60-day deadline

This is the big one. Once you withdraw money from your 401(k), you have exactly 60 days to make sure it gets deposited into another tax-advantaged account, be it a new 401(k) or IRA. If you miss that deadline, the IRS will assume you cashed the money out (so you’ll owe those massive penalties we mentioned before).

The exceptions: In August of 2016, the IRS said “OK, fine, life happens,” and introduced a list of 11 reasons why they might forgive you for missing the deadline. It includes things like your check got lost and was never cashed, your home was badly damaged, or you experienced a death or serious illness in your family.

Company stock

This one’s important, too: If your old 401(k) includes stock in the company you just left, there are tax advantages that you may sacrifice if you roll those assets into an IRA. (And because the investment options for a new 401(k) will be determined by your new employer, they aren’t likely to let you bring your company stock with you there.) It might be better for you to either keep your company stock in your old 401(k), or maybe to move it into a taxable investment account. If you’re in this situation, definitely ask a tax pro for help figuring out what’s best for you.

Involuntary cash-outs

If your 401(k) has more than $5,000 in it, your previous employer must allow you to keep your money where it is. But if you have less than $5,000, that’s not guaranteed — it costs companies money to have people on their 401(k) plan, so this rule helps to protect employers.

If your balance is less than $1,000, your employer might just cut you a check. If that happens, get it into an IRA or new 401(k) ASAP so you don’t miss the 60-day deadline.

If you have between $1,000 and $5,000, your employer has to contact you in writing to tell you your options. Then you have to tell them what to do with your money next. If you don’t, they’re allowed to transfer your money into an IRA on your behalf. This is called an “involuntary cash-out” (also a “mandatory cash-out” or an “involuntary distribution”).

A couple of important notes here: First, this $5,000 benchmark only counts for the money you put in while you worked for that employer. Even if your balance is, say, $20,000, if you only put $4,000 in while you worked for that employer, they can move your entire balance to an IRA. Second, employers usually reassess every year. So if you’re barely over $5,000, and then a market drop puts you below $5,000, they can move you.

How does a 401(k) rollover work?

There are two main types of rollovers: indirect and direct. Here’s how they typically go.

Indirect rollovers

  1. You tell your new plan administrator or IRA provider that you’d like to initiate a rollover.

  2. You tell your old 401(k) administrator that you’d like them to empty your account.

  3. They mail you a check, made out to you. 20% of your account balance is withheld to pre-pay your taxes in case you miss the 60-day deadline.

  4. You deposit the funds into your own bank account.

  5. You make out a check to your new plan administrator/IRA provider and mail it to them. This check has to be for the full account balance. (Yep — you have to come up with the cash to replace that 20% withholding.) Then, if the check’s deposited within the 60-day timeframe, you can get your 20% back at tax time.

That’s a lot of steps and a lot of money changing hands, and you have to float the 20% out of your own pocket — less than ideal, and definitely risky. Generally, a direct rollover is much smoother and has less room for human error.

Direct rollovers

  1. You tell your new 401(k) administrator or IRA provider that you’d like to initiate a rollover.

  2. You tell your old 401(k) administrator that you’d like to roll your funds into the new plan.

  3. They mail or electronically deliver a check directly to your new plan administrator/IRA provider, made out to them. No taxes are owed (assuming you’re transferring “traditional to traditional” or “Roth to Roth”). The funds are deposited into your new plan.

Much more straightforward.

Where you roll it over matters, too

Women retire with two-thirds as much money as men and live six to eight years longer. But Ellevest IRAs are built to do something about that.

First things first: We’re a fiduciary. That means your interests come first, always. When you tell us you’re interested in a rollover into an Ellevest IRA, we’ll help you upload your latest 401(k) quarterly statement so we can see what you’re paying (or could be paying) in fees. Then we compare that to what you’d pay with us — and tell you what we found, even if we’re not your least expensive option. And if you do decide to roll over your 401(k) to Ellevest, our rollover queens will make it super easy. They’ll answer your questions, talk you through your options, and help get the paperwork started with your old provider.

Once you’ve rolled over, we’ll invest your money with the goal of getting you to a retirement income equal to 90% of what you’re projected to make right before you retire. (That’s more than other firms might aim for, but we think it’s safer that way.) Then we’ll give you a plan designed to get you there (or better) in 70% of market scenarios. (Others expect to get you there only half the time. Again: We think this is safer.) And — you know it — we account for the fact that women’s salaries typically peak earlier than men’s do, that women usually get paid less, and that women take more career breaks (which can also hurt their retirement savings).

Taking control of your money means knowing what you have, where you have it, and why.

Oh, and one more thing. Ellevest Impact Portfolios allow you to invest for both returns and in companies that advance women.

Whatever you decide to do with that old 401(k), it’s all about one thing: being intentional with your investments. Because taking control of your money means knowing what you have, where you have it, and why.


Disclosures

© 2018 Ellevest, Inc. All Rights Reserved.

You may or may not have noticed that we linked to Investopedia.com for some info in this article. FYI, Investopedia (“Solicitor”) serves as a solicitor for Ellevest, Inc. (“Ellevest”). Solicitor will receive compensation for referring you to Ellevest. Solicitor will be paid $3 for each email registration and up to $1,000 when an individual becomes a client. You will not be charged any fee or incur any additional costs for being referred to Ellevest by the Solicitor. The Solicitor may promote and/or may advertise Ellevest’s investment adviser services. Ellevest and the Solicitor are not under common ownership or otherwise related entities.

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Ellevest Team

The Ellevest team is working to help women reach their financial and professional goals.