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What is a 401(k) Rollover?

August 27, 2021

Once you set up your 401(k) and arrange for monthly deposits, for the most part, your account runs in the background, working hard to prepare you for a relaxing retirement. Knowing that you’re safely saving for retirement each month can give you some major peace of mind. However, you can’t just set and forget your 401(k), especially when you leave a job or are getting ready to retire. This is where 401(k) rollovers come into play. 

What does it mean to roll over a 401(k)? Keep reading for the answer to that important question, as well as insight into how to arrange a rollover and your rollover options. 

What does it mean to rollover a 401(k)?

What a 401(k) rollover is and why one may occur is pretty straightforward. When you leave a job that offers you a 401(k) for a new job or are preparing to retire, you’ll need to take the funds from your employer-sponsored 401(k) and transfer them into a different retirement account. This process is referred to as a 401(k) rollover. 

Your 401(k) rollover options

Don’t worry; you have choices about what happens once you lose access to your employer-sponsored retirement plan. Your 401(k) rollover can head in a few different directions: 

  • Rollover to a new 401(k) plan

  • Rollover to an IRA

  • Lump-sum distribution

  • Keep the 401(k) plan with your former employer (not always possible)

In the event that you’re starting a new job and currently have a 401(k) plan through your employer, you may be able to roll that over directly into your new company’s 401(k) plan. But that isn’t always an option. 

If you’re wondering, “Can I rollover my 401k to an IRA?” The answer is yes. You always have the option to transfer the funds from your existing 401(k) plan into an IRA or a Roth IRA.

If you don’t want to roll the funds over, you can do a lump sum distribution, meaning you can take your money out of the account. However, a lump sum distribution comes with some drawbacks. Not only will taking the money out instead of rolling it over cause you to lose out on the opportunity to grow your funds, but you’ll also get hit with a 20% withholding tax if you’re under 59 1/2. 

While it’s not a guarantee, many companies actually keep your former 401(k) with them even after you leave your job. You can speak with your plan sponsor about your options for remaining in the plan.

How long do you have to roll over a 401(k)?

Your plan sponsor will either directly transfer the funds to your new retirement account or mail you a check. If you’re mailed a check, you have just 60 days to deposit the funds into a qualified account if you want to avoid the early withdrawal penalty.

How taxes come into play

Whether you’re starting a new job or retirite, what you decide to do with your 401(k) when leaving a job can have tax consequences. When you roll over a retirement plan distribution, you generally don’t pay taxes on any of the funds in it until you withdraw money from the new plan. By rolling over your 401(k) into another retirement account, you’re serving two purposes: 

  • Saving for your future

  • Growing your investment, tax-deferred 

If you don’t roll over your 401(k), the funds taken out in the lump sum distribution may be taxable on a federal, state and local level. You may also be subject to a 10% early distribution penalty, unless you are at least 59 1/2  or eligible for an exemption. 

If you choose to do a lump sum distribution, the employer who sponsored the 401(k) account will typically withhold 20% of the account balance to help you prepay the taxes you may owe.

How to roll over a 401(k)

The process of rolling over your 401(k) will vary depending on if you do a direct rollover or a 60-day rollover. Let’s examine both options. 

Direct rollover

What is involved when you direct rollover a 401(k)? 

You can do a direct rollover if you’re about to get a distribution from a retirement plan (in other words, when you leave your job). Instead of getting a check from the plan sponsor, you can request to have that payment made directly to your new employer-sponsored 401(k) or an IRA. Your plan administrator can walk you through what this process looks like, as it can vary depending on your unique plan administrator. In some cases, you will still be issued a distribution in the form of a check, but that check will be made payable to your new retirement account. Because you’re going to deposit these funds into a retirement account, no taxes will be withheld by the plan administrator.  

If you’re rolling over your former employer’s 401(k) straight into the plan offered by a new employer, you’ll need to arrange this transfer with your new 401(k) plan administrator. In some cases, you may have to choose to keep your funds in the same investments you had before, but other plans allow you to transfer the lump sum and then choose new investments. 

You will need to complete any required forms to move your funds from your old employer’s plan to the new one. Your previous plan administrator will need to send the new plan administrator the money from your account (either by a check or electronic transmission). 

60-Day rollover or indirect rollover

When it comes to a 60-day rollover, the distribution is paid directly to you, and you need to deposit the money into a new retirement plan within 60 days. You can choose to deposit all of the distributed funds or just a portion of them, but only depositing a portion can have tax implications, as keeping that money outside of a retirement account will count as an early distribution. Again, your plan administrator can walk you through everything you need to do to make this happen. 

Depending on where you are in your career or financial planning, a 401(k) rollover can be a helpful way to keep track of finances and continue to grow them in a new employer-sponsored plan. 

Want to save more in your 401(k), but credit card debt’s getting in the way? Tally can help you pay down your credit card debt faster so you can put more money towards the goals that matter to you, like saving for a happy retirement.