Step-By-Step Guide to Rolling Over Your Old 401(k)


Last year, I left my job at a bank holding company in the Midwest, packed my things, and headed to law school on the East Coast. There’s one thing I forgot, though — my 401(k). Well, I didn’t exactly forget it; I just left it hanging for the past year. But no more! It’s summertime, I’m out of school, and I’m ready to get my finances in order. It’s time to roll over my 401(k) — and tell you how you can, too. (See also: 4 Reasons Why a Roth IRA May Be Better Than Your 401(k))

Before we get into the step-by-step guide of rolling over a 401(k), though, let’s go over some basics.

What Is a 401(k)?

Sure, you probably know that a 401(k) is a retirement investment vehicle that allows you to put away pre-tax money, and that your contributions are often matched (if not dollar-for-dollar, then at least at some proportion) by your employer. You may not know, however, that there’s generally a waiting period before new employees are allowed to invest in the funds (ours was two months). You might also be unaware that while employers may offer matching funds, they also often require you to remain with the company for a certain number of years before you’re eligible to receive those funds. At my company, that period was five years. If you move on earlier than that, you forfeited all employer contributions to your 401(k).

Why You Should (Almost Always) Roll Over Your 401(k)

Why should I roll over my 401(k) in the first place, you ask? Well, here’s a post we did a while back covering the considerations you might look at in deciding whether to roll over your 401(k). In general, it is a good idea to move your 401(k) because plan administrators charge a fee for managing the account. While the fee is worth it when you’re receiving employer contributions and contributing with pre-tax money, that benefit goes away as soon as your employment ends. What’s more, if your 401(k) balance is less than $5,000, you’re required to cash out or roll over your account upon leaving the company.

What Exactly a 401(k) Rollover Is

When you leave a job, you have several options regarding your 401(k):

  1. Leave it where it is (if it’s over $5,000)
  2. Cash it out
  3. Roll the account into your new employer’s plan
  4. Roll the account into an IRA or a Roth IRA

The fourth option, rolling over your account into an IRA or Roth IRA, is what is traditional meant by a 401(k) “rollover.”

We’ve already established that it’s rarely a good idea to leave your 401(k) with your former employer. It’s also generally a very bad idea to cash out your 401(k) (you’ll end up paying 30% or more in taxes — check out Wells Fargo’s 401(k) Early Withdrawal Costs Calculator to find out exactly how much you’ll be paying). There’s also no real benefit to rolling over your old 401(k) to your new employer. Your investment options are limited, there are other limitations that don’t exist with IRAs, and your employer doesn’t match those old funds in any way. The bottom line is this — if you’ve left your job and you’re not in dire financial straits, roll over your 401(k).

Choosing a Traditional or Roth IRA

Characteristics of a traditional IRA are:

  • Individuals can contribute pre-tax money to investments that grows tax-free
  • Distributions taken after retirement are taxed as ordinary income
  • There are no income limits
  • Individuals must start taking minimum distributions by age 70½

Characteristics of a Roth IRA, on the other hand, are:

  • Individuals cannot contribute pre-tax money (i.e., you pay with after-tax income)
  • Qualified distributions taken after retirement are tax free
  • There are income limits (you can’t contribute if you make over $105,000 per year if single or $167,000 if married filing jointly)
  • Individuals do not need to start taking minimum distributions at any point

In general, if you’re eligible for both a traditional and Roth IRA, you should go for the Roth unless you expect to be in a lower tax bracket when you retire. It can also be smart to go the route of diversifying and have one of each type of account. If you’re like me (eligible for both but expecting to be ineligible for a Roth IRA as my income rises), you’ll stick with the Roth for now and open a traditional IRA later. Check out CNNMoney’s guide on which type of account is right for you for more guidance.

Importantly, note that if you’re moving your money from a 401(k) (funded with your before-tax contributions) to a Roth IRA (funded with after-tax contributions), you will owe taxes at the time of conversion. After 2011, though, you can spread this over two years. For me, the benefit letting my money grow tax-free in a Roth IRA account outweighs the relatively small amount I’ll owe in taxes.

Last note — prior to 2010, if you wanted to convert your 401(k) to a Roth IRA, you had to go through an irritating two-step process of rolling over your 401(k) to a traditional IRA and immediately converting it to a Roth IRA. After 2010, all plans are supposed to offer the direct-to-Roth IRA option. Be aware, however, that some still do not offer this.

And Now, A Step-By-Step Guide to Rolling Over Your 401(k)

Once you’ve decided that you should roll over your 401(k), there are four basic steps you’ll need to take to actually move your money.

1. Open Your IRA or Roth IRA

Find and open an IRA/. Check out this article from Kiplinger or this article from Get Rich Slowly on how to choose the right Roth IRA for you.

2. Contact Your Old 401(k) Plan Administrator

For me, this one involves digging around in my records to find the retirement plan website and login information. From there, I can find the forms I’ll need to fill out to make the transfer. Then I’ll just need to fill them out and submit them.

3. Confirm That Your New IRA Is Able to Receive Your 401(k) Funds

Just in case, you’ll want to confirm with your new IRA account provider that everything is in place to receive a direct transfer from your old 401(k).

4. Confirm Direct Transfer From Your 401(k)

While filling out paperwork and verifying transfers, make sure you go with the direct transfer option — that way, your old plan simply sends your money to your new IRA account. Your other option is to have your 401(k) plan cut you a check, which will be for 80% of the fund balance (20% is temporarily withheld for taxes). You’ll need to deposit the full 100% old balance in your new IRA, though, (meaning you’ll need to make up that withheld 20% from personal funds) within 60 days. If you do deposit the full amount, you’ll get the 20% withheld when you file your taxes the following year. If not, you’ll be subject to early withdrawal fees.

So there you have it — the guide to rolling over your 401(k), and how I’m planning on rolling mine over in the next few weeks. Good luck!

Had any experience with rolling over your 401(k) or thoughts on the matter? Share your thoughts in the comments!

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Guest's picture

Great article Janey. Very thorough. One of the things that investors should be cautioned about before rolling over their 401K is the Age-55 Rule, especially if they are not able to find work. I would typically tell people that have been laid off to at least wait until they find a new job before completing the rollover. Once they complete the rollover, the Age-55 Rule is not available (it's not available in IRA's).

Janey Osterlind's picture

Good point! The more I'm researching 401ks and rollovers, the more I'm learning about the various rules I never even knew existed. I didn't know, for example, what exactly the Age-55 Rule was: that employees who leave their employer during the year they turn 55 or more can take a distribution from their company retirement plan without paying the 10% early withdrawal penalty (though they'll still pay income tax on the distribution). Thanks for sharing your advice!

Guest's picture

I have two 401k plans I've been hesitant to deal with. This is very useful information I'll use to make the needed rollovers in the next month or so.

Janey Osterlind's picture

Glad it's been helpful! I would always check with a financial professional for a second opinion on what the best plan is for you - as John points out below, there's always some changes to the process, like the taxes on a 401k-to-Roth IRA conversion possibly being all due in one year now, rather than the two-year possibility available in 2011. Good luck!

Guest's picture
John Schmoll

Great article. Very thorough. It is a fairly simple process, but it can be easy to trip over the number of steps needed to make sure it is done correctly. That's why your thoroughness is so helpful. One comment on the article though, I do believe that the ability to spread the tax burden of conversion over two years was only available during the 2011 year. I am fairly certain that the ability to spread it does not exist if initiating the conversion in 2012.

Janey Osterlind's picture

Thanks for pointing that out, John! I checked with a CPA friend, and she agrees with you that she doesn't think the two-year time frame is available anymore to spread taxes from your 401k to Roth IRA conversion.

Guest's picture

A potential advantage between the 401()k) and IRA topic is that by rolling over our 401(k) into an IRA, we may acquire advantage of a few additionaly beneficiary options that are non existent with the 401(k).