How do IRA and 401k rollovers work?
Retirement accounts are a great way of saving for the future, but they’re not preferable for everyone. If you want to move your money out of your 401k, 403b, 457, or IRA, the best way is to do a rollover.
If done correctly, rollovers are tax-free and a straightforward solution to moving money between retirement accounts. But there can be rules, limitations, and risks involved. In this post, we explain the process of doing a 401k or IRA rollover, when you’ll be eligible, and the reasons why you should consider one.
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How to rollover your IRA and 401k
A rollover is a term meaning the action of moving money from one account into another account.
You’ve likely accumulated money in several retirement vehicles throughout your career. You might have 401ks, 403bs, 457s, IRAs. If you decide to move your money from where it is currently to a new institution, this is a rollover.
You can do a rollover between any employer plan, even if they’re the same. For example, you can move your money from one 401k into another 401k, or you can go from a 401k to an IRA account.
There are two main types of rollover. One is a direct rollover, which is a straightforward, trustee-to-trustee transfer. The other is a 60-day rollover, which can be riskier.
How to rollover your IRA and 401k using a trustee-to-trustee transfer
A trustee-to-trustee transfer moves your money from one institution directly to another institution. To do this, your existing account holder has to make out a check to your new account holder, with your name listed as “FBO” (for the benefit of).
Let’s use an example. If you have a 401k or an IRA held with Fidelity, but you want to move it to Charles Schwab, Fidelity has to write a check addressed to Charles Schwab followed by FBO and your name.
Key things to know about a trustee-to-trustee transfer:
- The check is not made out to you, so you cannot put it into your account
- The government have not put a limit on how many trustee-to-trustee transfers you can do so you can do this as many times as you like
- This is a simple, straightforward, and risk-free way to do a rollover
- If you are moving money into an IRA, you should set this up before you instruct your institution – you do not have to put money into an IRA to open one
How to do a 60-rollover for your IRA and 401k
With a 60-day rollover, your institution writes the check directly out to your name. From this date, you have just 60 days to put it into an IRA, otherwise, it will be taxable. If you’re under the age of 59 and a half and you go over the 60-day limit, you’ll owe a 10% penalty as well as tax.
For 401ks, there is one additional caveat. 401ks are required by law to withhold 20% of your money, even if you get them to write a check out to you. This can be an issue.
If you have $100,000 in your 401k, for example, and the institution withholds $20,000 in taxes, you only have $80,000. You will get that $20,000 back, but only when you next file your taxes. To complete the rollover in the meantime, you’ll need to find an additional $20,000 to roll over the full amount.
Key things to know about a 60-day rollover:
- You have to complete your rollover within 60 days, or you will be taxed
- If you’re under the age requirement, you will also face a penalty
- You can only do one 60-day rollover in a calendar year
We prefer using a trustee-to-trustee transfer. This way, you do not run the risk of having to pay income tax on your money, and it’s a more straightforward solution.
Why you shouldn’t use a 60-day rollover as a personal loan
Some people choose to use a 60-day rollover as a personal loan, but we advise against it. You may do this to loan yourself money in an interest-free way.
This is a high-risk strategy as you’re bound by the 60-day rule to get your money back into that account. This is a fixed rule and if you miss your 60-day deadline for any reason, whether you didn’t manage your time well, or you didn’t have enough money to put it back in to your account in time, then you’re faced with an irreversible problem, and bigger tax bill, and potentially a penalty too.
It’s a very risky strategy and not one that the IRS likes, so we urge you to be cautious if this is something you’ve heard or read about.
What makes you eligible to rollover your IRA and 401k
If you’re under age 59 and a half and you try to take money out of any retirement account, such as 401ks and IRAs, you will be penalized for it.
However, if you’re over age 59 and a half, the government now considers you eligible to use that money. Most 401k, 403b, and 457 plans allow you to do rollovers whenever you want. So, if you meet the age requirement, you can do a rollover without any penalties or tax concerns, providing you do it correctly.
One other way you become eligible for a 401k rollover is following a separation of service. This is when you leave your company for one of the following reasons:
- Transitioning into a new company
- If you get laid off
- If you retire before 59 and a half
If you’re leaving your company, you may want to consider doing a rollover as you may not be eligible again for some time.
Why should you rollover your IRA and 401k
Your company might match your 401k contributions and offer you investment choices, so why would you choose to rollover your 401k into an IRA?
Firstly, 401ks have lots of hidden fees. You may not be aware of just how much you’re losing in fees for your 401k. Sometimes your employer will pay these, but they can also be passed along to you, the participant, without you knowing.
With an IRA, there’s a far higher level of transparency. You own every aspect of your IRA, so you can know each fee that gets charged to your account – if any. There are no admin fees with an IRA, so the only possible charges will be mutual fund or ETF fees if you use your IRA to buy those.
Secondly, it’s a myth that you get better rates if you have a 401k with a big company. It is not true that you get better rates based on what company you’re with. It’s also worth noting that your investment options are very limited in a 401k. An IRA has far more investment opportunities available.
Thirdly, 401k plans limit how much activity your account can have within a given year. Some plans may only allow you to make a change once every quarter or biannually. If you like to manage your money actively, then an IRA might be more suited to you.
It’s also challenging to manage your funds in a 401k. If you want a financial planner to help you handle your 401k, there’s very little that they can do. With an IRA, a financial planner can manage and monitor your money much more closely.
Finally, if you have multiple retirement accounts, you may want to make them easier to manage by consolidating them all into a singular, traditional IRA.
So, those are the reasons why you might want to rollover your 401k into an IRA. But why might you not want to?
There’s one time when you might not want to do a rollover, and that’s if you’re aged between 55 and 59 and a half and you’re no longer employed with the company your 401k is with. The IRS allows people above the age of 55 to take distributions of their 401k without penalties. If it’s in an IRA, you have to be 59 and a half to avoid the penalty. If you’re within this window and want access to your 401k money, we advise you to take distributions instead of doing a rollover.
How to execute a rollover
To do a trustee-to-trustee transfer or 60-day rollover, call your institution directly. They will have specialists available to help you do a transfer, but they are not there to give you advice, so make sure you’ve researched your options beforehand.
If you’re continuing to work at your company, this is called an in-service rollover. In this case, you stay in-service at your company, keep the 401k account, but roll out the balance into a traditional or Roth IRA account. Your 401k will stay the same, you will still make contributions and get the match, but your previous balance will now be in an IRA.
When you speak to your institution, they’ll ask you to verify your identity and address and then ask where you’re sending the money. Make sure you already have your IRA in place so that you can send the money over smoothly.
Your institution will then write the check out to the new institution if it’s a trustee-to-trustee transfer or directly to you if it’s a 60-day rollover.
You will rarely need to do any paperwork, and if you do, your institution can walk you through any documents that they need. Your institution may also ask you to review a tax notice, which explains the tax-risk of a 60-day rollover, much like we have in this post.
Ultimately, a rollover should be a simple, smooth process, resulting in putting your money in an account that you’re happy with.
If you’re considering doing a rollover or have any questions about IRAs, 401ks, 403bs, or 457s, our team can answer them. We work with these accounts every day and can offer you tailored advice and information based on your situation. Do consider booking a complimentary 15-minute call with us to find out how we can help you.