How to Properly Roll Over an IRA or 401(k)

Daniel Penzing
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Have a new job? Don't lose the benefits from your 401(k) and roll it over into a new account following these steps.

Let’s just say you have a 401(k) at your previous employer. You have new job with benefits now. You really want to keep the additional benefits you are now getting. Here is how you do it.

Open a Rollover IRA at your new place of employment. These typically come in several colors like blue or red. Or sometimes even orange. Because you can rollover a 401(k), the rollover must be taxable.

The rollover can be transferred to an IRA and not pay the taxes. Or you can leave it in your 401(k) and pay the taxes.

Make sure you do not change the investments in your 401(k) as you are rolling it over. If you do, it will typically be wrapped around the new employer’s plan.

This will not let you to invest in the ones you were previously invested. Always leave the investments as they are. Or your rollover will not be allowed.

Once your 401(k) is in your rollover IRA, your taxable amount is now larger. Your taxes are a lot lower on the rollover than on other investments, but be careful. The new employer will also charge you for it. This is why you want this to be your last stop before retirement.

Why Should I Roll Over My 401(k) or IRA?

A 401(k) plan is a type of retirement plan that lets you invest pretax income from your paycheck into mutual funds. When you retire, you take out the money in your account and use it for retirement.

An IRA, short for Individual Retirement Account, essentially does the same thing, only you set it up and manage it by yourself. If you roll over an IRA or 401(k), you decide how the account gets invested and how much you can withdraw on each payday.

Why Get Started With an IRA or 401(k) Plan?

From a tax perspective, these funds provide important tax breaks. Namely, you pay taxes on your 401(k) withdrawals or distributions in retirement, rather than having to pay them from your income tax before that. That means you can take more money out to boost your retirement savings tax-free.

You also have more investment choices with a traditional IRA or 401(k) than a Roth IRA. You can easily select different types of funds, stocks, and mutual funds, while Roth accounts tend to limit your investment options further.

What if I’m Not Ready for Retirement?

You don’t have to wait for retirement to roll over your 401(k) or traditional IRA. Many investment options let you start setting money aside immediately. If you’re under age 59.5, roll again penalties apply.

Should I Roll Over My 401(k) to an IRA?

Rolling over or transferring a 401(k) or other employer’s retirement plan into an individual retirement account (IRA) is not always the best choice. In fact, financial advisors generally recommend against doing so if your company offers a solid matching contribution.

You have two basic options if you want to roll over the funds with your employer. You can either do a direct rollover or an indirect one.

If you choose a direct rollover, the money in your employer’s retirement plan is transferred directly to a qualified IRA. You will have a number of options from your IRA provider, many of which can be invested in CDs, traditional stock mutual funds, or redemptions made to the same retirement plan.

A direct rollover is the most difficult one for employers to manage, which is why employers tend to prefer the indirect route.

When you choose an indirect rollover, you are given a check from your employer that you can deposit into whichever financial institution you wish. This transaction takes place without the employer’s interference and is commonly referred to as a free rollover.

Our Pick for an Easy Way to Check Out Your 401(k)

There are very real penalties imposed by the IRS if you allocate funds or take a distribution from your 401(k) before the age of 59.5. However, it is possible to do so… but it is not recommended.

However, since there is a wide range of available options for 401(k) plans and IRAs, it is important to narrow down your choices and to look for one that suits your circumstances best.

Just as an example, some people are self-employed, some people are not, some people have been with the same company for over four decades and are collecting a final lump sum early and some people’s situations vary like so many others. That’s why it’s so hard to claim that a certain method is correct for everyone.

One thing’s for sure, though – and everybody can do it. You can check out your 401(k) online. It’s a simple process that anyone can do and it takes only a matter of minutes.

Other Permissible Rollovers

The rules governing the distribution of IRA assets at death are sparse. Beyond the required distributions that must begin at age 70 1/2 and the fact that you cannot roll your account balance into an irrevocable IRA (which allows distributions to continue based on life expectancy), there are few other rules.

Subject to the above requirements, it seems as though you can roll (or transfer) your IRA assets to an IRA of another custodian. However, the IRS simply doesn’t talk about it. In point of fact, when I got the IRS to agree with me in an informal conversation, they did so only after persuasion.

In the absence of rules from the IRS, I would assume that there is no problem in rolling a traditional IRA (that includes growth through reinvestments) to a 401(k) or another IRA, but only if you have no penalty-free withdrawals. This makes sense: the rollovers can be done without penalty, but you’re still going to have to pay income tax on the growth.

General Rollover Terms

The key to any retirement plan money move is to ensure that the recipient plan accepts the coming transfer. Therefore, the first step in a rollover is determining whether the intended participant will accept the funds being rolled over to the recipient retirement plan. The first step in that determination is to find out if the recipient plan accepts rollovers and to assess the maximum amount that can be transferred.

All of the terms and conditions for accepting a rollover, including any maximum transfer amounts, are listed in the official plan document. Prospective rollover participants can reference the plan document to find the published policies or call the plan administrator to discuss them. Frequently, the plan administrator is able to provide answers to FAQs related to rollovers.

When determining if a participant is eligible to participate in a particular plan, it is necessary to learn the potential consequences of excluding the participant or terminating his or her participation in the plan. This information can also be found in the plan document, typically in sections detailing the plan’s features, benefits or eligibility.

The Mechanics of a Successful Rollover

There are a few simple mechanics to rolling over a 401k to an IRA. The first step is to open a Traditional IRA or a Roth IRA with a separate institution from the 401k plan you are leaving (e.g. an institution other than the custodian of your 401k plan). The second step is to initiate a direct rollover of the funds from your 401k plan into your Traditional or Roth IRA. It is important to note that you can also make a trustee-to-trustee transfer, which is essentially the same thing as a direct rollover.

If you want to roll money from your 401k plan directly into a new employer’s 401k plan, that is going to be a slightly more complex process. This is because direct transfers from one plan to another plan are limited to retirement plans that accept such transfers.

The third step is to make sure to check your new IRA or Roth IRA brokerage account to make sure that the withdrawal has been received. That’s it! If you’ve completed these three steps, congratulations! You’ve successfully rolled over your retirement assets from one account to another.

Step 1: Set up your new account before beginning the transfer

Process:

If your old account will remain open after the rollover, close any new accounts before initiating the rollover. You'll have fewer payments to track and these funds cannot be managed with the new accounts.

Open a replacement account before initiating the transfer. This new account will ensure you have a place to hold your funds while the rollover process takes place.

You can roll over money from one or more accounts into the replacement IRA. However, you cannot roll money from your IRA into an account belonging to someone else.

However, if you own other investment vehicles including stocks, mutual funds or annuities, you can roll over this money into your new IRA.

After transferring any retirement accounts from your old financial institution to your new IRA, request that the old institution send a check directly to the new institution, or make a check payable to the IRA account at the new institution. This will help to ensure that your money is deposited directly into your new retirement fund.

If you have a 401k through your employer, and you're reading this as part of your search to find the best robo-advisor, take a look at Wealthfront's 401k product.

Step 2: Contact the current plan administrator

Most IRA and retirement plans should have the option of rolling over to a new account upon termination. Often it is the plan administrator who initiates the request, so it’s a good idea to contact them directly. When you call, request that they initiate the rollover to either your bank or a financial advisor who you have already worked with in the past.

Pro Tip: Although you can choose to roll over your retirement funds into any type of investment account, it is always best to roll over balances into accounts containing within the same family. For example, you can choose to roll over an existing IRA with Fidelity into an IRA with Fidelity.

Step 3: Make sure the check is made out to the new plan trustee

Forms are filed with the IRS and a check is usually made out to the new plan trustee. Form 5500 is typically filed annually to reflect the investments that the plan is holding. This is a formality that ensures the IRS is kept aware of the changes to the plan.

The 5500 is filed annually, but the file can be accessed online at the Department of Labor website. The link is "Form 5500 Fillable Forms", and you may have to enter the plan's "Employer Identification Number".

The 5500 will show the participant accounts, beneficiary distributions, named beneficiaries, retirement and death benefits, and more. It's not an accounting of the money in the plan, but rather the descriptions used to identify the money.

Step 4: Deposit the check within 60 days

If you already have an IRA or 401(k) and you want to move the funds from the old account into your new account, you can do an “in-kind” transfer, which means you’ll receive a check for the value of the IRA or 401(k).

After you get the check, you have 60 days to deposit it into the new account. If you don’t deposit the money, you’ll trigger taxes and penalties.

Step 5: Report the rollover on your income taxes

After you’ve completed the rollover, your investment firm will probably inform you that you’ll need to report the transaction on your income taxes. This will be on Form 1099-R, which is generated by the company holding the funds. You’ll need to submit a copy of Form 1099-R to the IRS with your tax return.

There are a few things to keep in mind:

You need to report the entire amount of the rollover as taxable income. While a portion of the funds may have come from a non-taxable source (such as a traditional IRA), the entire amount of the rollover needs to be included on the 1099-R as taxable income. This is calculated as the sum of the distributed and taxable portions.

The distributions and taxable portions of the rollover will be reported on separate lines on the 1099-R.

Need Help With an IRA?

Roll It Over!

IRA rollovers are common and should be considered if your current IRA provider is either high-priced or subpar in comparison to your new plan.

If you don’t want to wait until you’re 59 1/2 to take a distribution from your current 401(k) or IRA plan, a tax-free rollover may be the solution. Here’s how it works.

Simply convert your account to a new IRA or 401(k) plan with a favorable provider, such as CobraNet.

The transfer is completed separately by your old plan provider and your new provider. This is accomplished by a direct rollover, which means you have full control over the transaction and when it takes place.

Generally, it’s best to move your money as soon as possible, but you have up to 60 days from the time you receive the distribution to perform the rollover.

Keep Your Investments Going

If you are thirty and have a 401(k) plan, you might be starting to think about retirement. When you get to this age, you have to start saving in order to have the retirement you want.

If you are leaving a company and look at your 401(k) options, you might have the option to take a lump sum distribution and rollover your 401(k) to an IRA. If this is the case, check with a financial planner on the pros and cons of this option.

If you do go through with the rollover, the amount that you roll over will depend on when you want to start taking out money. If it is before you are fifty-nine and a half, you will have to pay a 10% penalty on the amount taken out. If you are sixty and a half or older, there will be no penalty.

Once you have decided on whether you want to take the rollover, you have to decide what type of IRA you want. There are several types, and each have their own tax benefits. The main types are a traditional IRA and a Roth IRA.