401(k) & IRA Rollovers: Everything You Need to Know

Millions of Americans utilize IRA and 401(k) investment accounts for tax-advantaged retirement savings. By investing pre-tax dollars into a brokerage account, you can pass off the tax burden to your retired self when you can reap the benefits of a lower tax bracket. But 401(k) and IRAs function in different ways with varying levels of control for the account holder. Plus, both types of accounts can be rolled into Roth versions, which change the way taxes are paid on your investments. Read on to learn everything you need to know about 401(k) and IRA rollovers.

If you need assistance with your finances, work with a professional financial advisor from Good Life Financial Advisors of Mt. Pleasant. We’re ready to help create a personalized plan for your specific needs.

401(k) Accounts vs Individual Retirement Accounts (IRAs)

401(k)s and IRAs offer the same type of tax-deferred savings, but the similarities end there. The 401(k) account is an employer-sponsored plan, which can only be opened on behalf of employees at a business, but not by the employees themselves. Investment options in a 401(k) are often sparse, but the contribution limits are much higher.

An IRA isn’t tied to a specific job or place of employment. Instead, an IRA is opened, funded, and managed by an individual. A traditional IRA offers a much wider range of investment options than a 401(k) and often carries lower fees. Of course, those perks come with a downside—the current contribution limits for an IRA are only one-third of the limits for a 401(k). For 2021, those contribution limits are $19,500 for 401(k) accounts and $6,000 for IRAs.

Rolling Over Your 401(k)

If you change jobs, your 401(k) doesn’t automatically come with you. You’ll be faced with a few choices—you can keep the plan as is, cash it out, roll it over into your new employer’s 401(k) plan, or roll it over into an IRA.

Cashing out your 401(k) is usually the least efficient option. You’ll owe taxes on the money right away, and if you’re under 59.5, you’ll pay the 10% early withdrawal penalty, too. So don’t cash it out unless you really need the money.

Leaving the account open with your former employer might sound like a bad idea too, but occasionally, it makes sense. For example, if you leave your job to become self-employed, you won’t be able to access a new 401(k) plan. Or maybe your new employer has limited investment options, so keeping the old account open makes sense there as well. Plus, 401(k) accounts have federal protections from bankruptcy, so you won’t lose the money if your old employer goes out of business.

Most of the time, you’ll want to roll the account over. You can roll the account into your new employer’s plan, or open an IRA if they don’t offer one. In most cases, this is a simple process. If you’re rolling over into a new 401(k), you can contact your old plan’s administrator and give them the information about the new account. You can have more than one 401(k) account open at once, but consolidating them makes it easier to keep track of. Plus, if your new plan has better investment options or lower fees, you’ll want all of your annual contribution going there.

If you roll over into an IRA, you’ll have to choose the account and brokerage you want and contact your old plan’s administrator to get the funds dispersed (usually via check). You’ll have 60 days to deposit the funds into the new account or face a tax bill.

Rolling Over into a Roth IRA

Rolling a 401(k) into a Roth IRA is another option, but you’ll need to consider the tax consequences. Rolling a 401(k) into another 401(k) or traditional IRA is a simpler process because taxes are levied in the same manner—you get a tax break now, but pay later when you access the funds. Roth accounts are funded with after-tax dollars and investments grow tax-free, so taxes will need to be paid on any money flowing from a traditional 401(k) or IRA into a Roth IRA.

Roth accounts offer several advantages over traditional tax-deferred retirement vehicles. Not only do investments grow free from taxation, but Roth IRAs have relaxed rules on borrowing and distributions. With a Roth, you’ll have no required minimum distributions and the money you put into the account can be borrowed back without tax or penalty.

Before rolling your 401(k) or traditional IRA over into a Roth, make sure you set aside enough money to pay the tax bill—and NOT from the funds in the 401(k) already. If you pay the taxes with money from the 401(k), you’ll be hit with the early withdrawal penalty. You need to roll the full amount into the Roth and pay the tax bill with other funds.

Before rolling over an existing retirement account into a new one, always consult with your advisor to make sure the move is advantageous. In a few cases, it could make more sense to just leave the account alone, especially if your new employer has weak offerings or high fees. But if you want the advantages of a Roth or the simplicity of a single account, rolling over your existing account is worth considering.

Work With an Experienced Financial Advisor

This is everything you need to know about 401(k) and IRA rollovers! If you have any remaining questions, reach out to a team member from Good Life Financial Advisors of Mount Pleasant today!


The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.

A Roth IRA offers tax deferral on any earning in the account. Qualified withdrawals of earning from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being open for five years, whichever is later, may result in a 10% IRS tax penalty. Limitation and restriction may apply.