Rolling Over 401(k): An Essential Guide

According to the U.S. Census Bureau, 34.6% of working age individuals born between 1956 and 2005 have an employer-sponsored retirement plan such as a 401(k). If you are like most Americans, you are no longer spending your entire working life at one company. According to a 2021 U.S. Bureau of Labor Statistics study, individuals born between 1957 and 1964 held an average of 12.4 jobs between the ages of 18 and 54.

If you parted ways with an employer and have a 401(k) account, you may want to roll over that 401(k) into another retirement account. There are several options to consider. Before you decide, it’s important to know the tax impact of the rollover decision you make. Here’s a guide to help you choose the right rollover for your financial situation.

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Should you roll over your 401(k)?

You have several options for your 401(k) after you leave an employer. You can roll over your 401(k) to an individual retirement account (IRA), roll it over to your new employer’s 401(k), cash out your 401(k), or leave it in place with your former employer. Each of these options comes with different rules and tax implications.

Cashing out a 401(k)

You may be able to cash out your retirement plan, depending on your age and financial situation. This option must be weighed very carefully, because you must meet specific criteria to avoid hefty penalties. Typically, you need to be at least age 59½ to withdraw from your 401(k). Any time before that may subject you to a 10% early withdrawal penalty. There are, however, some exceptions that allow you to bypass the penalty.

• You may make a withdrawal if you have a qualifying and permanent disability.
• You may take a series of substantially equal periodic payments (SEPP) after the separation of service from your employer and continuing, at a minimum, annually for at least five years or until you reach age 59½, whichever comes second.
• You may make a withdrawal upon separation of service from your employer after the calendar year in which you reach age 55.
• You may make a withdrawal to pay an alternate payee under a qualified domestic relations order (QDRO), such as in a divorce.
• You may make a withdrawal to pay for your medical care up to the allowable medical expense deduction for the year.
• You may make timely withdrawals to reduce excess employee contributions, excess matching employer contributions, or excess elective deferrals.
• You may make a withdrawal because of an Internal Revenue Service (IRS) levy on the retirement plan.
• You may make a withdrawal related to a qualified disaster for which the IRS has granted relief.
• A beneficiary may withdraw from the plan upon your death.

Rolling over a 401(k) to an IRA

Rolling over your 401(k) to a traditional IRA is simple. In a direct rollover, the plan administrator of your 401(k) wires the funds to the trustee of your IRA. Alternatively, you may choose to receive a check from your 401(k). As long as you deposit the funds into your new IRA within 60 days, it is considered an indirect rollover and avoids the taxes and early withdrawal penalties of a normal distribution.

Rolling over a 401(k) to a Roth IRA is not as straightforward. Because a 401(k) is a tax-deferred account and a Roth IRA is an after-tax account, you will have to pay taxes at the time of your rollover. Still, a Roth IRA does come with certain benefits. The distributions you take in retirement are tax free. It is also beneficial for high-income earners to roll over into a Roth IRA if they would otherwise be unable to contribute due to income limitations. This is called a “backdoor Roth.” You can, again, avoid the penalty for early withdrawal if you follow the 60-day rule.

Rolling over a former employer’s 401(k) to a new employer’s 401(k)

It may simplify your life to roll over your former employer’s 401(k) into the new employer’s 401(k). If you value having all of your money in one account, this may be the best option for you. You can do a direct or an indirect transfer of funds from your former 401(k) account to the new 401(k) account.

Leaving a 401(k) with a former employer

If all of the other options seem daunting, you can simply leave your 401(k) with your former employer. The above options will still be available at a later date. Be aware that there are a few situations that may require you to take funds out of your former employer’s 401(k). For example, if you have less than $5,000 in the account, your former employer may require that you close it.

401(k) rollover rules

The simplest option is a direct rollover, in which you transfer funds directly from your 401(k) to another retirement account. An indirect rollover can be completed tax free and penalty free as long as you follow the 60-day rollover rule. You have 60 days from the date of your distribution from the 401(k) to complete the deposit of funds into the second retirement account.

You can roll over all or part of any 401(k) distribution except:

• Required minimum distributions (RMDs).
• Loans from your 401(k).
• Hardship distributions.
• Excess contribution distributions.
• Substantially equal payment distributions.
• Distributions used to pay for medical or life insurance.
• Dividends on employer securities.
• S corporation allocations treated as deemed distributions.

How to roll over your 401(k) in four easy steps

Step 1: Decide on the type of the new account

Choose the kind of account into which you will roll over your 401(k) funds. Do you want more-direct control over your own account? If so, an IRA may be a good choice. Does your new or former 401(k) offer lower fees? Do you have access to a financial advisor with your new 401(k)? Consider when you may want to start withdrawing from your retirement account. Once you’ve decided on a 401(k), traditional IRA, or Roth IRA, you’re ready to take the next steps.

Step 2: Open the new account

Once you’ve decided to roll over your funds into a new account, you will need to open it. Talk to your plan administrator at your new job if you’ll be setting up a 401(k). If you’ve decided to roll over into an IRA, a financial advisor can help you open your account. Empower offers you the ability to set up an IRA that can be managed conveniently from an online dashboard.

Step 3: Initiate the rollover

Fill out the necessary paperwork to begin the rollover process. Remember, a direct rollover avoids the complications of an indirect one.

Step 4: Complete the rollover within 60 days

If you’ve chosen an indirect rollover, be sure to complete the deposit into your new account within 60 days of the distribution from your former 401(k).

What to consider when rolling over your 401(k)

A 401(k), traditional IRA, and Roth IRA all have their pros and cons. The main benefit of a 401(k) includes your ability to take penalty-free withdrawals if you separate from service with your employer after the age of 55. This is lower than the 59½ age limit for most retirement accounts, unless certain exceptions apply.

You may also be able to avoid the required minimum distributions (RMDs)s that 401(k)s and traditional IRAs typically require beginning at age 73 (as of 2023, previously age 72) until you retire if you do so later than age 73. A drawback of the 401(k) is that you are limited to your employer-selected investment options.

A traditional or Roth IRA may offer you more investment choice and greater direct control over your investment decisions. A Roth IRA does not have RMD rules like a 401(k) or traditional IRA. Traditional IRAs are tax deferred, like a 401(k). Roth IRA contributions are made after tax and allow for tax-free withdrawals in retirement.

Both traditional and Roth IRAs have much lower annual contribution limits than the 401(k), if you intend to keep contributing to your retirement account. The 401(k) contribution limits for 2024 are $23,000 for employees under age 50 and $30,500 for employees age 50 and over, which includes the $7,500 catch-up contribution. In 2024 the contribution limits on a traditional IRA or Roth IRA are $7,000 for individuals under age 50 and $8,000 for individuals age 50 and over, including the $1,000 catch-up contribution. However, once you’ve left an employer you can no longer contribute to your 401(k) account at that employer even if you leave your funds at that plan.

The importance of a direct 401(k) rollover

A direct transfer is typically your best option. Because you never touch the funds, it ensures that you do not trigger any unnecessary taxes or penalties. An indirect transfer, where you receive a check as a middleman,requires that you complete the transfer within 60 days. If you do not roll over the funds in time, it may trigger the 10% early withdrawal penalty.

What’s more, a distribution from your former 401(k) account is subject to a mandatory 20% tax withholding if the check is payable to you. This is the case whether or not you intend to roll over the funds into a new retirement account. The full amount must be rolled over within the 60 day time frame, so you may find yourself out additional funds from another source if you go the indirect route. You will have to wait until tax time to receive the mandatory withholding back in the form of a tax refund. This does not apply if you receive a check payable to the receiving plan or IRA. However, you still need to deposit the funds within 60 days.

You will need to roll over the full amount within the 60-day time frame to avoid taxes on the rollover. For example, assume you distributed $100,000 from your 401(k) in an indirect rollover. Your former employer withheld $20,000 for the mandatory tax withholding. If you only roll over the $80,000 net that you received in the check, you will have to include $20,000 of income on your tax return. If you want to avoid taxes entirely, you will need to contribute $20,000 from another source to complete the full $100,000 rollover.

TIME Stamp: If you roll over your 401(k), be sure to follow the tax rules

You have options for existing 401(k) accounts. It’s important to know the tax implications of each type of rollover. The easiest option may be to leave your funds where they are. If you’re considering cashing out your retirement account and aren't at retirement age, be aware it will likely come with penalties.

Frequently asked questions (FAQs)

What is a 401(k) rollover?

A 401(k) rollover is a transfer of your funds from a 401(k) into another retirement account. It can be direct or indirect. In a direct rollover, the funds are transferred directly from your 401(k) to another retirement account, such as an IRA or a new 401(k). In an indirect rollover, a check is written to you, as the account holder, and you have a 60 day window to redeposit the funds into a new retirement account.

What if you have an existing 401(k) at your previous employer?

When you change jobs, you have four main options to handle your existing 401(k). You can:

• Roll over the funds into an IRA.
• Roll over the funds into a 401(k) at your new employer.
• Cash the money out of the existing account.
• Leave it where it is with your former employer.

Should I roll over my 401(k) or not?

It depends on what you need. If you roll over your 401(k), you can choose the type of account that best suits your financial situation and planned retirement lifestyle. If you roll it over into another 401(k) or a traditional IRA, you can keep saving for your retirement while your funds continue to grow tax deferred. Rolling over into a Roth IRA will require that you pay taxes in the current year, but it allows tax-free withdrawals in retirement.

If you don’t roll over your 401(k), you have two options. Cashing it out likely comes with a 10% penalty if you’re under age 59½. You can also just leave it in place as long as you have more than $5,000 in your account. Neither choice prevents you from rolling it over at a later date.