HOWTO Do A 401K Rollover Correctly

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 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 mean’t 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).

STEP 1

Open a Traditional IRA account at a broker of your choice.

STEP 1
401k Rollover Transfer Chart
STEP 2
IRA: Enter personal Information
STEP 3
401k Rollover Transfer Chart
STEP 4
Wells Trade-rollover
STEP 5
Traditional IRA-rollover

STEP 2

Once you have your account details, request a 401K Rollover form from your old 401K custodian. By law they have to provide this and the company HR has no say in this (in case you had a bad exit!). There is no expiry date on when you can do a rollover. You can request a rollover whenever you choose once you quit your job

STEP 3

This is a very simple form where you specify what you wish to do with your 401K funds. Choose a Traditional IRA rollover and provide the account info from STEP 2.

STEP 4

One crucial information that you’ll be required to fill out is to the question, whom should the check be made out to. Do not fill in your name! The check should be made out to your new IRA custodian.

So if you were called Guybrush Threepwood and your IRA custodian was Wells Fargo Advisors, you would write:

To: Wells Fargo Advisors (FBF Guybrush Threepwood)

This is called a trustee-to-trustee transfer.

STEP 5

That’s pretty much it! Once the rollover is complete, you should see the funds deposited in your IRA. You are now free to invest!

FAQ

If I do a 401K rollover to an IRA, would that count towards the IRA contribution limit for the current year?

Will there be a fee to do a rollover?

Your old custodian will ding you with a fee. Usually ranges from $40 to $100 which will be taken out of your 401K funds. The new custodian won’t charge you for incoming funds, but might have annual maintenance fees. Check with your custodian.

Can I rollover all my old 401Ks into a single eligible account?

The company I worked for went belly up. Can I do a rollover?

Yes. Contact your old 401K custodian. Your 401K funds are protected by Employee Retirement Income Security Act (ERISA). Note that, ERISA only protects your funds in case of company bankruptcies, not the value of your funds! If you had all your money invested in Enron, you have no one to blame, but yourself!

Can I do a rollover from my current job’s 401K account?

Usually no. There are special circumstances like a merger, but normally, you can’t. You can do a rollover once your leave your job.

Is there a limit to the number of rollovers I can do?

No, but you can only do 1 rollover within a 12 month period if you do an indirect rollover. Although, no such limitation exists for trustee-to-trustee transfers.

Conclusion

When you leave behind your old job for a better opportunity, in your excitement, don’t forget your 401K! Consolidation will make your life a lot easier. Also, know the difference between a direct and indirect rollover. Always opt for the former. Your old 401K provider may or may not explain the difference, but be aware there are consequences (60 day window and 20% tax withholding) with an indirect rollover.

Continue reading here: Demystifying Mortgages For The First Time Home Buyer

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