If you leave a job where you have a 401k, you obviously take your 401k with you when you leave. What to do with the 401k after you go is a matter for you to carefully decide. Rolling over your 401k into another form of retirement investment is one option, but so is leaving your 401k alone with its current brokerage and investment strategy. Either option may be the right one for you, depending on certain factors.
The best way to rollover a 401k is to start out by making sure rolling over your 401k is the right choice for you.
There are two primary ways and circumstances to rollover your 401k. Either you can roll it over into an IRA or, if you get hired by a new employer with its own 401k plan, roll it over into that employer’s 401k. Before deciding to rollover your 401k, evaluate factors like your age, retirement plan, future employment options and investing strategy. Without care and caution, you could be stuck with early-withdrawal fees or other penalties.
401k to 401k
Rolling over a 401k from one employer to a 401k with another employer is probably the easiest 401k rollover to make, although it is not without its potential hazards. Do not simply accept the default automatic withdrawal amount until you make sure it fits with your budget. If either the percentage taken each pay period, or the amount of your pay differs between employers, the new 401k could leave you with less money to live on than your old one.
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Ensure the investment strategy you take with the new 401k matches either your old 401k or your newly revised investment goals. Your new employer’s human resources department likely has someone able to walk you through all the pieces of the rollover. Be sure you are clear on any rules applying to your new 401k in case they differ from the rules of your old one, such as withdrawal rules.
Choose an IRA
If you are rolling over your 401k into an IRA, such as if you do not get a new job right away or your new employer has no 401k program, you still must choose what type of IRA account to open. The primary difference between the two main types of IRAs, Traditional and Roth, is taxes are deferred on deposits on the former and on withdrawals on the latter. In other words, the deposits you make into a Traditional IRA are not taxed, but withdrawals you make upon retirement are.
With a Roth IRA, the reverse is true: you deposit taxed money but withdrawals upon retirement are untaxed. Which you choose depends on whether you need the tax benefit more now or you can put it off until later. Additionally, if you rollover a 401k into a Roth IRA, you must pay taxes on the amount you roll over. If you roll over your 401k into a Traditional IRA, you do not pay any taxes.
Request a Direct Rollover
The best way to rollover a 401k into an IRA, whether Traditional or Roth, is through a direct rollover. When you specify this type of rollover to your 401k provider, the plan writes a check directly to the new IRA account rather than to you personally. This protects you from the possibility of withdrawal fees and penalties. In the alternative to an indirect rollover, in which the 401k funds are distributed to you personally, those funds are subject to a 20 percent withholding. This amount is returned to you in whole or in part after you file that year’s taxes and your ability to pay your tax obligation is assured.
If you do not rollover those funds into a new IRA or 401k plan within 60 days of receiving them, they are considered a cash withdrawal. As a cash withdrawal, it is subject to income tax. If you are younger than 59 ½ years of age at the time of the withdrawal and do not qualify for any exceptions, an additional 10 percent tax on early withdrawal is applied.
Invest Your Funds
In a 401k plan, you select an investment strategy, which the plan provider implements with your deposits. In an IRA, every deposit you make into your account, including the first one direct deposited by your former 401k provider, remains sitting there as cash until you invest it in something. You must pick investments aligned with your investing strategy and apply your deposits to those investments.
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If you choose active management of your investment, you need to choose a broker who lets you manage your investments for little cost.
It is vital when choosing a broker to check the fees you may have to pay, including trading commissions, management fees, mutual fund sales loads or transaction fees, expense ratios and administrative fees. It is best to find a broker who offers benefits like the following:
- Low trading commissions.
- No fee mutual funds.
- No or low account minimums.
- Access to a full range of stocks, mutual funds and ETFs.
If you want to be less involved in the active management of your IRA account, there is an alternative available, known as hands-off investing. For the vast majority of personal investors, hands-off investing represents the best way to rollover a 401k into an IRA, as it requires the least of you and leaves the most to the professionals. Unless you are a professional or expert investor or have the time to amply research companies, stocks and funds, your investments are likely best left in the capable hands of knowledgeable and experienced financial professionals.
Hands-off investing involves having a diversified portfolio selected for you based on your investment goals and needs into which your regular deposits are automatically invested. One of the best types of hands-off investing is to use robo-advisors who produce portfolios of low-cost mutual funds according to your chosen preferences and rebalancing them automatically in relation to those preferences as conditions change. While you do pay a fee for this service, robo-advisors cost far less to use than standard investment managers.
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By Alfred Wickham –