The Step-by-Step Guide to Rolling Over Your 401(k)

By Alaina Tweddale on 25 March 2015 0 comments

If you've recently switched jobs, you may be wondering what to do with your retirement accounts. First, congratulations on thinking ahead and planning for your future. Rolling over accounts is an important step toward continuing to build your financial future, and we've created this step-by-step plan to help you navigate the process.

That said, before you figure out how to rollover your 401(k), it's first important to know what not to do.

Don't Take a Distribution

It's tempting to let your former employer send you a check to cash out your account, but, unless you're over age 59½, this can be a huge mistake. Your former employer is required to withhold 20% of the distribution. On top of that, the IRS will charge you an additional 10% penalty if you're younger than 59½.

To break it down in dollars and cents, let's assume there's a $10,000 balance in your 401(k) and you're in a 25% tax bracket.

$10,0000 – $2,000 (20% Withholding) – $1,000 (10% Tax Penalty) = $7,000

You've just taken a $3,000 hit on your portfolio. That's a heavy hit to take. Plus, you'll no longer have that money working in the market for you, which means you're more likely to end up like the majority of Americans who fear their retirement funds are lacking.

Some people take distributions because they're not sure how to make ends meet between jobs (a valid fear). But taking a 401(k) distribution is one of the most expensive ways to bridge the gap when you're between jobs.

But some distributions happen by accident. If you don't know how to conduct a 401(k) rollover, the paperwork can be confusing and it's easy to check the wrong box or make an inaccurate assumption.

If your former company has already sent a check directly to you, there is a remedy, if you act fast. You'll have 60 days to get the funds deposited into an IRA. There is a bit of a hitch, though. You'll be directly responsible for making up the 20% that was withheld by your former employer.

So, What Should You Do?

If you're just starting the 401(k) rollover process, you'll have a few options.

Keep Your Funds In the Current 401(k)

If your 401(k) balance is greater than $5,000, you'll have the option to keep the money right where it is. The upside? No paperwork. The downside? Well, there are a few.

  • It's easy to lose track of your accounts. The average person holds 11 jobs by age 46. That can add up to a lot of retirement accounts, if they're not being rolled over or combined.
     
  • Retirement plan quality varies greatly. Not all 401(k)s are created equal. There are drastically different fee structures and varying levels of investment options. Most separated employees would be better off moving their money into an account with a low-fee provider like Vanguard or Fidelity, each of which offers vast investment options for your IRA.

Some employers automatically distribute 401(k) funds for separated employees if the balance is below the $5,000 mark. If this is you, you'll want to get your rollover going immediately.

Roll Your Funds Into Your New Employer's Retirement Plan

It's not a bad idea to keep your retirement funds in the same place, so that you don't lose track of previous accounts. Not all 401(k) plans accept rollovers, so if you want to go this route, check with your new employer first.

If rollovers are accepted, ask your new employer for instructions on where your former employer should send your existing 401(k) funds. Once you have these rollover instructions, call your former employer and ask for the forms you'll need to fill out.

Once the paperwork is complete, your former employer should send your account balance directly to your new employer's plan. There shouldn't be any taxes withheld or penalties assessed for a direct rollover. (See also: 10 Easy Ways to Supercharge Your Retirement)

Roll Your Funds Into an IRA

This is my favorite option, because low cost mutual fund giants like Vanguard or Fidelity generally offer more investment options than most employer 401(k) plans, and they're usually cheaper, too.

The first step is to open a new IRA account with a high-quality, low-fee investment provider (like Vanguard or Fidelity). You can open an account online with most investment providers by simply going to their website, selecting the Open An Account option, and looking for an account option for rolling over employer-sponsored retirement plan account. To open the new account, you'll need the following:

  • Your personal information, like social security number, birth date, email address, and street address;
  • The current balance in the 401(k) account that you're rolling over;
  • Your former employer's name;
  • The name of the investment (usually a mutual fund of exchange traded fund) in which you plan to invest your funds. If you don't know what to choose, a popular option is a target retirement fund, which automatically rebalances your account as you age and get closer to retirement.

Once the rollover account is open, the next step is to call your former employer and ask for their rollover instructions. They will likely have a form that needs to be completed and will likely ask for the name and address of the investment house where the funds are to be sent. They'll also need your new rollover IRA account number.

Make sure the check they send goes directly to the investment house where you've opened the new account. The check should be made out to the new investment house, with your name and new account number notated on the check. Do not have the check sent directly to you.

To complete the transaction, some employers will require a letter of acceptance. If yours is one that does, you'll need to go back to the investment house where you opened the IRA and make the request. Not all employers require this, but it's not uncommon, either, meaning getting the form together shouldn't be a big deal for your new account holder.

Once all the forms are signed and completed, it usually takes about three weeks for a rollover to be complete. The funds should be sent directly from your old employer to your new account holder and you should receive a confirmation either in the mail or email. Again, there shouldn't be any taxes withheld or penalties assessed for a direct rollover. (See also: How to Set Up An IRA to Build Wealth)

The whole thing should take about 10 minutes in paperwork and three weeks in wait time (while your old employer sends the funds to your new account holder). It's a small price to pay for building a secure retirement.

Have you rolled over your 401(k) recently? Did you hit any snags or was it smooth sailing? Tell us about it in the comments below.

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