HOWTO Do A 401K Rollover Correctly

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On an average, a person will switch about 9 jobs during his working career. If he was lucky and smart, he probably enrolled in 401K plans when available. Now, if he didn’t bother consolidating his 401Ks, that’ll be 9 different accounts to remember at the time of retirement!

When you decide to leave a company, make a graceful, but clean break and don’t leave anything behind – ESPECIALLY your 401K!

It isn’t really that hard to do a 401K rollover. There are multiple options when deciding what to do with your 401K money, when you leave behind your old job.

401K Rollover Options

  • You could rollover your old 401K into your new 401K
  • You could rollover your old 401K into a traditional IRA (Recommended)
  • You could rollover your old 401K into a ROTH IRA
  • Cash it out! (Not recommended)

401K To 401K Rollover

This is probably the simplest of all rollovers. When enrolling in your new 401K plan, depending upon the custodian, there may be an option to rollover your old 401K.

If this is an option, you will have to initiate the transfer from your previous custodian. Ask them for the 401K rollover form and fill out the details. It is a very simple form where you provide details on your new 401K account and request a simple rollover. What happens next is that your old custodian will mail a check to your new custodian and the money will be made available as a part of your new 401K account.

In order to do this, you must have the details of your new 401K plan.

401K To Traditional IRA Rollover

This is an option if say, your new employer doesn’t provide a 401K plan or, if you, like me, would like more control over your investment choices.

A Traditional IRA is a retirement account that you can open yourself. You can open one at your local bank if you so wished though I wouldn’t recommend it. A better place to park your retirement cash would be a stock broker. The simple reason being, with a bank, your investment options are limited to CDs which offer poor interest rates when compared to stocks and bonds that a stock broker will provide access to. The more options you have, the better!

The process is quite similar.

  • You open a Traditional IRA account at a broker of your choice and when you do, indicate that you will be funding it via a rollover
  • Once you have the account number, request a 401K Rollover form from your old custodian
  • Fill out the relevant details and indicate that this is a 401K to Traditional IRA rollover

A check will be mailed directly to your new Traditional IRA custodian in a few days.

401K To Roth IRA Conversion

With this option, things get slightly complicated! For one, you are talking about converting pre-taxed money into post-taxed account. See, the money in your 401K hasn’t been taxed yet. A ROTH on the other hand, takes in money that’s already been taxed!

Previously, this wasn’t even an option, you had to rollover your 401K into a Traditional IRA and then do a Traditional IRA to a ROTH conversion, but with Pension Protection Act of 2006, you now have the option of doing a direct rollover from your 401K into a ROTH account.

Be aware, there are eligibility rules and there are tax consequences. You have to pay taxes on the contribution and the earnings!

Some custodians don’t even provide this option even though IRS permits this. For example, when I tried to do this with my old 401K custodian, the only option I had was to rollover my old 401K to a Traditional IRA and then do a Traditional IRA to ROTH conversion.

Either way, you will pay taxes on a 401K to ROTH conversion, which is not the case when you do a ‘compatible conversion’ like a 401K to 401K rollover or a 401K to Traditional rollover.

Cash It Out!

This is the worst thing you can do with your retirement money! You can request a rollover form from your old 401K provider and opt to cash out your retirement savings. Please don’t! You will pay taxes and penalties and miss out on your retirement growth.

Direct And Indirect Rollovers

When your old custodian mails the funds directly to your new custodian, technically it is called a trustee-to-trustee transfer (direct rollover). An indirect rollover is when you decide to request a check from your old custodian and within 60 days, deposit the funds into your new account.

What Would I Choose?

Though I had the option of doing a 401K to 401K rollover, I chose to do a 401K to Traditional IRA rollover even though it meant a little more work since I had to open a new account with my broker before initiating the transfer. But then the benefits outweigh the effort!

Benefits of 401K to Traditional IRA Rollover

  • With a 401K, you are mostly limited to mutual funds, hand selected by the 401K custodian (which usually isn’t in your favor). With an IRA, you can choose how to invest your money
  • With an IRA, you have the option to invest your money in stocks, bonds, ETFs, mutual funds, treasuries or even just hold cash
  • You have the option to switch your IRA custodian any time you wish, unlike a 401K
  • Your IRA is not tied to your job!
  • Unlike a ROTH IRA, there aren’t immediate tax consequences with a Traditional IRA rollover
  • Most 401K rollovers are cash transfers and don’t permit ‘in kind’ transfers. With an IRA you don’t have to sell your holdings in order to do a transfer. (This has been my experience, but always check with your custodian first)

401K To Traditional IRA Walkthrough

Here’s a real life example of a 401K to Traditional IRA rollover with Wells Fargo advisors (formerly called Wells Trade).

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33 thoughts on “HOWTO Do A 401K Rollover Correctly

  1. I’ve quit two jobs with 401(k)s. The first time I cashed it out (stupid!). The second time I rolled it over into a traditional IRA. (smart!)

    Luckily (if you can call it that) the first time was a very small amount. I think I got less than $200 out of it.

    • Can’t blame you for cashing it out. In my experience, most 401K custodians don’t explain the tax consequence of cashing the money out.

      Lucky indeed that the amount was small!

  2. Wow, you have created a comprehensive resource here MC. Thanks for laying it all out.

  3. Great post with awesome pictorial steps. I ended up rolling over my 401K into Roth IRA after I left my first company. Turned out to be okay…

  4. Great post! Many people fail to realize that it will cost them 10% penalty and they have to pay their tax rate on the money taken. It is considered ordinary income.

  5. So many people leave the job & their money behind, which is typically a BIG Mistake; cashing it out is even worst (IMHO). The decision of Roth vs traditional IRA in this case depends on other money you have available.

    • Roth vs Traditional will depend upon knowing whether your tax rate will be more or less after retirement.

      But for keeping things simple, I’d say go with Traditional – you can always convert to ROTH at a later time.

  6. Great article MC. This is a great resource that I plan to share with my friends. It’s a simple but very helpful layout that explains the pros and cons to each scenario. Thanks for sharing this.

  7. Another thing to consider is if you have a 401k that is below $5,000 and quit your employer can drop you from the plan.

  8. I haven’t had to do a rollover yet but I have always wondered how it works. I didn’t realize there are that many different ways to do it. Really insightful step by step guide MC! -Sydney

  9. Excellent post on a process that confuses many people. I agree that the preferred approach for many people is to rollover to a traditional IRA where you have control. Then you can invest in low cost index funds and with some discount brokers, commission free funds.
    In some instances it is possible to transfer “in kind” so that funds are transferred and the “out of the market” issue doesn’t arise.

    • True DIY. A lot of what can and cannot be done depends upon the employer and the 401K provider within the framework provided by IRS.

  10. I agree with Hunter. What an awesome resource. There is so much thought and detail that went into this. Great job. Since I live in Canada, a 401 doesn’t apply to my but I definitely know where to point some of my American relatives.

  11. Lots of great information here! I like you you laid it all out in simple terms.

  12. Good post, Money Cone. There are certainly different ways to approach this, and you did a nice job.

    Cashing out is not good, generally speaking. Hard to imagine some people do that, when they’re not in financial distress.

  13. Great job on a comprehensive post! I’ll pick the same choice as well and roll it over to the traditional IRA. I want to put off paying tax as long as I can. :)

  14. Nice resource!! I am in my second job. First job I didn’t even have 401k (yes I was financially very brilliant then ;) ) If I had a 401k I might have probably cashed out. Now I know better, I will roll over the traditional 401k to IRA and the ROTH 401k to ROTH IRA to not pay any extra taxes. My husband’s 401k will be tricky to rollover because it is semi-managed.

    What plugin is that MC? I have been looking for something like this. Is it slidedeck? Pro or regular?

  15. Great post. Here is my confession: I did cash out my 401K once. It was a very small amount and I needed money. Really bad. So, there you have it. The biggest NO NO you listed first, I’ve done it. :)

  16. We roll over every time we switch jobs. Over time, keeping the funds compounding tax free is an awesome way to grow wealth!

  17. good resource to read. I rolled over previous 401(k) consolidation helps.

  18. This is so helpful, MC! I agree about moving to the IRA; the flexibility is so important! Thanks for a great step-by-step tutorial!

  19. MC strikes again! Another terrific resource. Will definitely refer to this when I switch jobs. Thanks!

  20. Good information. I would always roll it over into a Rollover IRA. When you do, make sure that you assign your beneficiaries properly though.

  21. This is one of the best posts I have read about 401K. Since I started investing on my 401K, I have been informed that cashing it out is the most stupid thing to do with it. So far, I have not done anything with it yet but definitely I will roll it over. but not now… not yet.

  22. I’ve had a couple friends leave my firm that ended up cashing out their 401(k)s. They were fully aware of the implications and did so for no other reason than the job switch affording them an excuse/opportunity to do so I suppose. aggghhh!

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