401k Rollover To IRA: What is it and how does it work?

thumb

When you are leaving a job where you have contributed to a 401k plan, you have three options: cash out your 401k, keep it in your current plan, or move it to another qualified retirement account. A qualified retirement account could be your new employer’s 401k plan, a Traditional IRA, or a Roth IRA. The movement of your 401k to this account is called a rollover.

Why You Should Rollover Your 401k To An IRA

Before we discuss why 401k rollover to IRA is the best option, let’s look at why you should not cash out your 401k.

Cashing out your 401k is a bad idea

Typically, this is the worst thing your could do to your 401k fund. When you cash out your 401k, you’ll be taxed on the withdrawal. The combined federal and state taxes could be significant due to the higher marginal tax rate that the withdrawal will bump you into. Also, you may be subjected to a 10% early withdrawal penalty if you are not yet 59 1/2. Assuming an effective combined federal and state tax rate of 35%, a $100,000 cashed out of 401k could cost you $45,000 in taxes and penalty leaving you with only $55,000.

401k rollover to IRA is usually the best course of action

Unless your current 401k plan is great — i.e., excellent investment options and low fees — this usually is not the best option. And unless you know for certain that your new 401k will be great, you shouldn’t consider a 401k to 401k rollover either.

With an IRA, you can usually lower your investment expenses significantly and gain access to much wider variety of investment options. You can even switch to a different discount brokerage firm to take advantage of different investment options, tools, features, prices, fees, etc. Additionally, you have the option of converting your 401k to a Roth IRA, which allows your retirement savings to grow tax-free.

How To Do A 401k Rollover To IRA

Now that you’ve decided to go with the 401k rollover to IRA option, here are the main steps on how you can accomplish the rollover.

  1. Open an Individual Retirement Account (IRA) with any financial institution that offers an IRA — usually, this end up being one of the many discount brokers. Here’s a guide to help you choose a discount broker. In general, you want to pick the investment company that offers the type of investments you want that are accessible at low trade commissions and fees.
  2. Inform your employer that you want to do a 401k rollover to IRA. Make sure your employer makes the check payable to the investment company that you choose. This is call a trustee-to-trustee transfer and it helps you avoid the automatic 20% tax withholding.
  3. Once the transfer is complete, your money will be sitting in some sort of interest bearing investment such as a money market account that earns very little interest. You will have to invest your money according to your asset allocation plan. The exact investment options you have will depends on your investment company. In general, you want to invest in a well-diversified portfolio of low cost and passively managed mutual funds or ETFs.

If you are facing this decision, consider performing a 401K rollover to IRA to take advantage of the opportunity to lower your costs and gain greater flexibility. Remember to research the investment company well before you open an IRA with them, and do your due diligence when selecting your investments. If you are uncertain, it’s usually a good idea to consult a professional to help guide you through this process and answer your questions.

Read more about

individual retirement account, IRA, taxes, discount broker, discount brokerage firm, 401(k) rollover to ira

Recommended articles

Get free updates

  twitter  via Twitter
  twitter  via Facebook
  rss  via RSS or Email

Share this article

Pinyo
Pinyo is the brain behind Moolanomy personal finance blog and a few other web sites. If you like this article, please subscribe for free daily email updates.

All posts by Pinyo

5 Comments

  1. gravatar
    dave
    September 1, 2009, 12:03

    IMO, converting to a Roth IRA may be a better option.

  2. gravatar
    Pinyo
    September 1, 2009, 14:50

    @Dave – This entirely depends on your age. For example, if I am 55 years old and have a sizable sum in my 401k, I wouldn’t want to pay all the taxes.

  3. gravatar
    shashi
    September 1, 2009, 19:04

    If you anticipate lower taxes in retirement, then ROTH may not be good. One should look into each individual situation to see if it makes sense.

    Also to rollover is good idea in most cases. It is not good if

    1) you dont control assets and just end up buying stocks and lose money
    2) you have very low cost index or passive funds in current 401k.

  4. gravatar
    Rick Vaughn
    September 4, 2009, 19:01

    Some great point you made here. In fact I’m right in the middle of a “rollover” and I was able to put it in a Roth IRA which I’m much happier about. Let’s hope my money keeps growing like it did last quarter 32%. YEAH!

  5. gravatar
    Faisal
    October 30, 2009, 1:44

    Self-Directed IRA’s Replacing Bank Loans?

Please share your comment:


Please do not use the name of your site or keywords.


Email will not be published.

Comment Rules: Constructive criticism is welcomed. Please use your PERSONAL name or initials and not your business name or URL, as the latter comes off like spam and I'll most likely delete your comment. Have fun and thanks for adding to the conversation! Here's our comment policy and guidelines.

5 blogs that link to this article:

If your trackback does not show in 24 hours, please resend to this trackback URI.

  1. 401k Rollover Rules
  2. Carnival of everything about personal finance - 10th Edition | nil2million.com
  3. High School Football
  4. Baby Boomers U. S. (The Blog) » Blog Archive » Baby Boomers Blog Carnival Fourth Edition
  5. Roundup – Labor Day Edition | Cash Money Life

Your Credit Score

Featured Reviews

Featured Articles

Recent Articles

Affiliate Relationships

As required by FTC regulations, please note that we have a financial relationship with many of the companies mentioned on this site. We occasionally review products or services that we have been given access to for free. However, we do not accept compensation in any form in exchange for positive reviews and the reviews found on this site represent the opinions of the author.
 

Important Notice:

The information found on Moolanomy is provided and intended for informational and entertainment purposes only and does not constitute financial, legal, or other advice of any kind. The information contained on this site is aimed at a general audience, and does not attempt to offer specific advice to your specific circumstances. If you are looking for professional advice, you should consult with an independent financial adviser.

This site contains information about third party products and services, such as credit card offers, online banking, discount brokers, and credit score services. While we endeavor to ensure that the information presented on this site is accurate at the time of publication, any offers and rates shown on Moolanomy can and do change without notice. Visit the official site of the offer for up-to-date information.

For additional information, please review our Terms and Conditions.

Archives By Year

2007, 2008, and 2009

Additional Resources

  • CheapLoans.co.uk - A simple way to find cheap loans. For a hassle free quotation, apply now!
  • Mortgage Refinance - FHA lender offers fixed rate mortgage refinance loans for consolidating adjustable rate debt and loans, getting cash back and financing a new home remodel.