401(k) Rollovers: What You Need to Know

Let's take a closer look at these potential options in turn.

First, what is a 401(k) rollover?

A 401(k) rollover occurs when you move money from your former employer’s 401(k) plan to another retirement account – either a new 401(k) plan or an IRA.

It’s important to understand that how you choose to roll over your 401(k) matters. You can typically choose to do a direct or indirect rollover (also known as a 60-day rollover).

For a direct rollover, you can ask your 401(k) plan administrator to transfer your funds directly to your new 401(k) plan or an IRA. Contact your plan administrator for instructions. Generally, no taxes will be withheld from your transfer amount.

With an indirect rollover, you’re requesting a distribution from a 401(k) to be paid directly to you (in other words, you’re taking hold of the funds). Such a distribution is typically subject to a 20% mandatory withholding tax. This is even if you intend to roll the money to another retirement account at a later date. Be aware that you have 60 days from the date you receive your retirement plan distribution to roll it over to another plan or IRA.

An indirect rollover is typically not recommended because if you don’t put the money (the full amount of the distribution) back into another retirement account within 60 days, you may have to pay income taxes on the distribution and a 10% early withdrawal penalty unless you’re eligible for an exception. (See also: IRS waivers on the 60-day rule.)

This is one reason why it’s often preferable to request a direct rollover when moving money from a 401(k) to another retirement account. If you have questions about your rollover options, consult a financial advisor or tax professional.

Requesting a 401(k) rollover is pretty straightforward, but you'll have to decide where you want to direct your rollover. 

Option 1: 401(k) rollover to a new employer’s 401(k) plan

If your new employer offers a 401(k) plan, you may have the option of rolling your old 401(k) into the new one. Not all 401(k) plans accept rollovers, however, so it’s important that you check with your new employer’s plan administrator.

And before initiating a rollover, check the fees and investment details of your new employer’s plan. Some plans could have higher fees and fewer investment options. But one benefit of rolling over to a new 401(k) plan is you can consolidate your 401(k) savings in one place, which means one less account to keep track of. 

A potential drawback to rolling over to a new 401(k) is that the process may take some time given the amount of administrative paperwork to facilitate the transfer. Also with some employers, you may be subject to a waiting period before you can join their plan. 

Option 2: 401(k) rollover to a traditional IRA

If your new employer doesn’t offer a 401(k) plan or if you don't like the plan options, you can choose to roll over your 401(k) into a traditional IRA. A traditional IRA may offer a wider range of investment options than a 401(k) plan. 

Good to know: When it comes to rolling your 401(k) funds from a former employer’s plan to an IRA, generally speaking, no tax is due if you roll over money directly from a 401(k) funded with pre-tax contributions (i.e., a traditional 401(k) plan) to a traditional IRA.

Option 3: 401(k) rollover to a Roth IRA

You could also roll over your 401(k) savings into a Roth IRA. But it matters whether you’re rolling from a Roth 401(k) plan or a traditional 401(k) plan.

Roth 401(k) rollover to a Roth IRA and the 5-year rule

If your old employer’s 401(k) plan is a Roth 401(k), you can roll the money directly over to a Roth IRA. Generally, you do not have to pay taxes for this direct rollover.

Good to know: Withdrawals from Roth accounts are subject to a “5-year rule.” Generally, in order to withdraw your earnings tax- and penalty-free from a Roth account, you must have had the account for at least five years (and be age 59 ½ years or older). But remember, even though the withdrawal of your earnings is subject to special timing rules, you can withdraw your contributions from your Roth account any time with no tax or penalty.  

When does the clock start for the 5-year rule when you roll over from a Roth 401(k) to a Roth IRA? The timing of the 5-year rule is tied to your Roth IRA when you initiate a Roth-to-Roth rollover. For example, if you roll over a Roth 401(k) account that you’ve had for eight years into a Roth IRA that you’ve only had for three years, you’d have to wait two years before you satisfy the 5-year test. See IRS’s “Retirement Plans FAQs on Designated Roth Accounts” for more information. 

Be aware that IRA distribution and rollover rules can be complex, so it’s a good idea to consult with a financial advisor if you have questions about your personal situation.

Traditional 401(k) rollover to a Roth IRA

If your old 401(k) is a traditional 401(k) plan, you could roll your funds over to a Roth IRA through a Roth conversion if you qualify.

Be aware that you'll likely have to pay taxes on the money you move (or “convert”) from a traditional 401(k) to a Roth IRA.    

The good news is that Roth IRA conversions are relatively common and your IRA provider should be able to guide you through the process. Most major banks and brokerage firms can help you complete the conversion.  

Not sure if you qualify for a Roth conversion? Talk to a financial or tax advisor for more information.

Alternatives to a 401(k) rollover: leave it alone or cash it in

Many 401(k) plans allow you to keep your account in place even though you’re no longer an employee of the company. You just won’t be able to contribute money to the account.

If your former employer’s 401(k) plan carries low management fees and delivers great returns, leaving your old 401(k) plan in place after you leave your job might be a reasonable option. But be aware that some employers might charge former employees higher fees, so definitely keep a close eye on those numbers.

But one potential inconvenience is that you would have to check the account from time to time. A 401(k) plan’s fees and investment strategy can change over time. This means you would have to monitor the plan’s performance and periodically ask yourself whether it’s still worth keeping in place instead of rolling it over.

Changing jobs can be stressful. So if you don’t want to move your 401(k) money right after you leave a job, you can always go back and roll it over later.

You also have the option of cashing out your 401(k) account by taking a one-time lump-sum distribution. But financial experts generally advise against this move, as your cash-out will likely be subject to a withholding tax, an early distribution penalty, and additional income tax.

Should I roll over my 401(k)?

As with every financial question, the answer is: It depends. 

Keep in mind that each option may have different benefits, trade-offs, and tax implications for your retirement savings. It’s a good idea to consult your financial or tax advisor if you have any questions before initiating a rollover. They can help you weigh the tax and investment implications, as well as other considerations, of each option.