This rollover transaction isn't taxable, unless the rollover is to a Roth IRA or a designated Roth account from another type of plan or account, but it is reportable on your federal tax return. You must include the taxable amount of a distribution that you don't roll over in income in the year of the distribution.
There's no required timeframe for rolling over your 401(k). If your balance is less than $5,000, your previous plan may be required to roll over your account. Note that if you do decide to do an indirect rollover, you'll have 60 days to deposit the check into your new 401(k) or IRA.
"One of the most important reasons not to roll over your 401(k) to an IRA is to have access to your funds before age 59½," says Marguerita Cheng, CFP®, CEO of Blue Ocean Global Wealth in Louisville, Kentucky. "They can be accessed as early as age 55, versus having to pay a 10% early withdrawal penalty in an IRA."
Most of the time, transferring the money from your old 401(k) into an IRA is your best option. That's because a rollover IRA gives you the most control over your investments. You see, an IRA gives you potentially thousands of mutual funds to choose from.
Taxes will be withheld. Then, you'll need to deposit the full amount withdrawn, before taxes, into a new 401(k) or IRA retirement savings account within 60 days to avoid taxes and early withdrawal penalties (if you're not yet at retirement age).
Key Takeaways
There is usually no transfer fee for rolling over your 401(k) into a new tax-advantaged retirement account. Account fees for your new account might be higher than the ones for your old account.
401(k) Rollover
The easiest way to borrow from your 401(k) without owing any taxes is to roll over the funds into a new retirement account. You may do this when, for instance, you leave a job and are moving funds from your former employer's 401(k) plan into one sponsored by your new employer.
With an indirect 401(k) rollover, on the other hand, you take on the burden of passing the money along. Your old account administrator will write a check to you, and then you'll deposit that money in your bank account so you can write a check to your new account administrator (all within 60 days).
The new plan may have lower fees or investment options that better support your financial goals. Rolling over your old 401(k) into your new company's plan can also make it easier to track your retirement savings, since you'll have everything in one place.
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
First, not all 401(k) assets can or should be rolled into an IRA. Ignoring this can cause expensive tax problems or lead you to miss some tax-minimizing and financial planning opportunities. A failed rollover may cause the entire balance to be distributed, which could make the withdrawal fully taxable.
Key Takeaways
Many investors leave money in a previous employer's 401(k) plan, but you have other options. Leaving the money with your old employer brings risks, including having less control over your savings. Rolling over your old 401(k) money to a new account may lead to investment and tax advantages.
When you roll over a retirement plan distribution, you generally don't pay tax on it until you withdraw it from the new plan. By rolling over, you're saving for your future and your money continues to grow tax-deferred.
As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%. The good news is that there's a way to take your distributions a few years early without incurring this penalty. This is known as the rule of 55.
Generally, there are no tax implications if you complete a direct rollover and the assets go directly from your employer-sponsored plan into a Rollover or Traditional IRA via a trustee-to-trustee transfer.
The IRS allows those under the age of 59 ½ to withdraw from their 401(k) plans without the 10% additional penalty if they do so in the form of a series of substantially equal payments (SoSEPP) over their remaining life expectancy.
If you don't roll over your payment, it will be taxable (other than qualified Roth distributions and any amounts already taxed) and you may also be subject to additional tax unless you're eligible for one of the exceptions to the 10% additional tax on early distributions.
If you seek full management of your account, rolling the money into an IRA will likely be your best option. For more hands-off investors, leaving the money in your previous plan or rolling it over into your new employer's 401(k) will allow the money to continue to grow tax-deferred while someone else manages it.
401(k) Rollover Rules
With a direct rollover, your old employer makes out a check to the new account address. Because the funds are directly deposited into the new account, no taxes are withheld. With a trustee-to-trustee transfer, the old plan administrator sends the funds to the new plan via an electronic transfer.
Roll it into a new 401(k) plan
The pros: Assuming you like your new plan's costs, features, and investment choices, this can be a good option. Your savings have the potential for growth that is tax-deferred, and RMDs may be delayed beyond age 73 if you continue to work at the company sponsoring the plan.
By age 50, you should have six times your salary in an account. By age 60, you should have eight times your salary working for you. By age 67, your total savings total goal is 10 times the amount of your current annual salary. So, for example, if you're earning $75,000 per year, you should have $750,000 saved.
Whether you roll over your 401(k) to an IRA, move it to your new employer's plan or let it stay with your old employer, the important point is to keep that money set aside for retirement. By keeping it in those specialized retirement accounts, you'll enjoy a tax advantage and accumulate more money for retirement.