Most professionals work for several employers over the course of their careers, so it’s not uncommon to have multiple 401(k) accounts with different providers. Consolidating these retirement accounts makes it easier to track your progress against your savings goals and ensures you can manage your retirement investments in a comprehensive way.
Remember, when you invest in a 401(k), your employer (or former employer) chooses the administrator and decides which investment options are available to you. If you choose to rollover the 401(k), your funds are invested in an IRA account which offers you full control of your savings and investments. With an IRA, you can choose a plan with the fee structure and investment options that you prefer.
401(k) to IRA Rollover Methods
The rules regarding retirement account distributions can seem complicated, discouraging some account holders from rolling over their 401(k)s to IRAs. Fortunately, special regulations apply in this situation and if you follow IRA rollover rules, there is no risk to the tax-deferred status of your contributions.
There are multiple ways to complete a rollover without incurring taxes and penalties. The first option is a direct rollover, which takes place when your plan administrator makes your distribution payment directly to your new retirement account. The plan administrator withholds no taxes and sends the check to the IRA custodian, made payable to the new retirement account.
Another method of transferring your retirement savings, the indirect rollover, is a bit more complex. In this case, the plan administrator distributes the funds from your current account in a check made payable directly to you. Typically, the IRS requires the current custodian to withhold 20% of the plan funds for taxes. This is to ensure that you abide by the IRA rollover rules and deposit the check into another qualifying retirement account in a timely manner. You then have 60 days to redeposit your retirement savings into your new retirement account in order to avoid taxes and penalties. Note that if the administrator withholds taxes, you will have to make up the difference when you deposit your funds into the new retirement account. If you do complete the rollover within 60 days, the withheld taxes will be returned to you after you file your tax returns.
Suppose, for example, that Stacie has $100,000 in a 401(k) that she wants to roll over to a new retirement account. If the money is sent directly to Stacie, she will receive $80,000, since 20% of the plan funds will be withheld. To avoid any tax penalties, Stacie will have to send the full $100,000 to the receiving account. If she can’t come up with the cash, the missing $20,000 will be taxable since the money was never transferred to the new plan.
Pitfalls to Avoid
Note that there are certain funds that you cannot roll into another IRA. These are ineligible distributions, and they include the following:
- Loans that your plan administrator is treating as a distribution
- Required minimum distributions
- Distributions resulting from your hardship application
- Excess contributions and relevant earnings that were distributed to you
- Distributions related to your substantially equal payments
- Withdrawals taken for payment of health, life or accident insurance premiums
- Distributions related to opting out of automatic contribution plans
- Employer securities dividends
- Distributions from S corporation allocations
Funds from any of these sources cannot be deposited into your IRA, and they will be treated as regular income.
3 Steps to Completing Your IRA Rollover
Consolidating your retirement accounts can be accomplished in three steps:
- Open your new retirement account or identify the account that will receive your rollover funds.
- Contact your current plan to initiate the rollover transaction – this typically requires completing some forms, and you will choose which rollover method you prefer.
- Confirm the transfer, either by depositing funds from a direct or 60-day rollover or validating that the direct rollover is complete.
Nothing in this article should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. This article is not intended as investment advice, and Wealthfront does not represent in any manner that the circumstances described herein will result in any particular outcome. Financial advisory services are only provided to investors who become Wealthfront clients.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.