Should you roll over your 401(k)?

To help save for retirement, many employees at companies in the U.S. take advantage of the 401(k) plan offered by their employer. By providing a tax-advantaged entry point into a selection of generally low-risk mutual funds, as well as the potential for matching contributions, 401(k) funds are continuing to gain traction throughout the workforce. But, as easy as they may be to manage, it can still be somewhat confusing to know what's next if an employee leaves the company. One common solution to this scenario involves what's known as a rollover.

"When workers leave a company, they won't be leaving their retirement savings, too."

Based on data from the U.S. Bureau of Labor Statistics, the average American worker may transition in and out of as many as 10 different jobs in their lifetime, with younger people being more likely to spend less than five years at a given company. If that job offered a 401(k) plan and the worker contributed to it, they might be hesitant to leave that company for fear of losing those savings.

Fortunately, contributions to a qualified employer-sponsored retirement plan are not forfeited upon termination or voluntary transition, as long as all rules regarding vested funds are met. That's because 401(k) funds are managed by the plan provider, not directly by the employer.

Once a worker knows they will be leaving their company, they generally have four options regarding the future of their 401(k) savings (assuming they are not already of retirement age):

  • Keep their 401(k) account as it is. The account may continue to grow from earnings on its investments, but the employee will not be able to contribute any new savings to it.
  • Roll over into a traditional IRA, another type of tax-deferred retirement account with slightly different rules and structure.
  • Roll into a Roth IRA, a type of account in which taxes are paid upfront on contributions but not on withdrawals in retirement. 
  • Transfer to the 401(k) plan of the new employer. This may be possible if both the old and new employers use the same plan administrators, but some fees or restrictions may apply.

Rollover basics

Some prefer to execute a rollover to keep old retirement accounts in the same place and simplify their portfolios. In addition, IRA providers tend to charge lower fees than 401(k) administrators, while also providing a much wider range of investment options.

Tax treatment

If you've decided to initiate a rollover, first consider if you would prefer a traditional or Roth IRA. In a traditional account, income taxes on contributions are deferred until you begin taking withdrawals from the account in retirement. A Roth account is essentially opposite - taxes are paid upfront based on your current income, but withdrawals can be made tax-free. If you want to roll your 401(k) over into a Roth IRA, you will need to pay taxes on the rolled amount, which can take a bite out of savings. However, if you have a Roth 401(k) that you want to roll into a Roth IRA, that tax treatment does not apply.

Researching accounts

The next step is opening your new IRA. Most major banks and investment brokers offer a variety of IRA funds, with the sheer number of options becoming a little overwhelming for some. Take the time to research your options to find the best IRA provider for you. There are many websites and publications that offer reviews and advice on how to pick the right provider, but in general, experts recommend looking for an IRA with the following attributes:

  • No account fees, or at least lower fees than what your 401(k) charges.
  • A broad selection of mutual funds or exchange-traded funds that don't charge commission or transaction fees.
  • A history of good customer support.
  • Minimum account balances that make sense for the amount of money you are rolling over.
IRAResearch IRA accounts online to find the best one for your needs.

The final step in the basic rollover process is actually transferring funds from your 401(k) into the IRA you've chosen. One of the easiest ways to do this is by asking your 401(k) administrator to perform a "direct rollover": The fund manager will cut a check made out directly to your IRA account.

Managing your IRA

After completing the rollover process, you can rest a little easier knowing your retirement savings have been consolidated into one account. Now comes the job of deciding how to manage those investments. If you chose to open a standard IRA, you can probably move money around as you see fit, but this is obviously hard to do well without expertise. Some IRAs will offer management services, often through an automatic, formula-driven method known as a robo-advisor. These accounts will reallocate funds depending on your expected retirement age, investment goals and other factors, usually for a small fee. Some IRAs function as target-date funds, a similar concept that periodically reorganizes investments based on a pre-selected retirement year.

The most common advice regarding any form of retirement savings is to play it safe and refrain from making frequent changes, especially if you are younger and further away from retirement age. Over time, your savings should grow into a useful source of funds later in life.

Investment products and services are not FDIC insured, not insured by any federal government agency, not a deposit or bank obligation, not financial institution guaranteed, subject to investment risk, including potential principal loss.

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