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How to Rollover 401(k) To IRA

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 13, 2022

Research the different IRAs available: IRA fees and investment options vary widely, so it is important to do your research before choosing where you will open up an IRA.

Choose an IRA provider: Once you have decided on the type of IRA that works best for you, it’s time to pick a financial institution to hold the account. 

Banks, credit unions, custodians, and brokers are among the most common IRA providers, and they each have their benefits and drawbacks, so you’ll need to do more research on those as well.

Contact the company where you have your IRA or Roth IRA: You will need to contact the company where you have your account and let them know that you’d like to roll over your 401(k) into this new IRA. 

The process varies depending on the financial institution’s policies, but it could take a few weeks or up to two months for everything to complete.

Connect your accounts: Once they have your 401(k) information from your employer, the financial institution will be able to link the two accounts so that you can start taking advantage of a whole new set of investment options.

 

Difference Between a 401(k) and an IRA

A 401(k) is an employer-sponsored retirement account. It’s a tax-deferred plan that you fund with pre-tax income. That means you don’t have to pay taxes on the money being saved for your retirement until you withdraw it during retirement.

An IRA, or individual retirement account, is also a type of tax-deferred plan, but it can be set up at any US financial institution–not just through your employer–and the types of investments are more diverse. 

You can have a traditional IRA or Roth IRA, or both. The big difference is how the IRS taxes withdrawals from your account. With a Roth IRA, you don’t pay any taxes on withdrawals, whereas you do with a traditional IRA.

You are likely to choose one over the other based on how much money you earn and whether or not you want to pay taxes on your investment earnings every year. 

For example, since you don’t have to pay taxes upfront with a traditional IRA, it’s generally best for people who know they’ll be in a higher tax bracket come retirement than they are now. 

For someone who knows he or she won’t be pulling out large sums of money–for example, someone who is just starting in the working world–a Roth IRA can be a better choice since you are taxed upfront.

Tax Implications of Rolling Over Your 401(k) to an IRA Account 

If you are considering rolling over your 401(k) to an IRA account, you need to know about the tax implications. 

The IRS considers IRAs as retirement accounts, and they will expect you to take withdrawals at some point. 

With a traditional IRA, you will have to pay taxes on the withdrawal, whereas, with a Roth IRA, there is no up-front taxation which could be advantageous if it’s likely that you’ll be in a higher tax bracket come retirement than you are now.

The difference between a 401(k) and an IRA is that with the 401(k), you are restricted by contribution limits because it is an employer-sponsored plan. 

With an IRA, you are not only able to contribute more, but you can also choose from a wider range of investments because it is your account. 

Your financial institution will require you to jump through some hoops if you want to roll over your 401(k) into an IRA, but the result could be a more diversified and less restrictive investment portfolio that can better secure your future.

Pros and Cons of Rolling Over Your 401 (K) To an IRA Account

The following pros and cons of rolling over your 401(k) to an IRA account may help you decide:

Pros:

  • You can contribute more to your IRA than a 401(k) since there are no contribution limits.
  • The IRA offers a wider range of investments than a 401(k).

Cons:

  • The process of rolling over your 401(k) can be lengthy.
  • There is an extra layer of fees, so you’ll need to keep track of whether or not they are worth it.

Final Thoughts

If you’re considering rolling over your 401(k) to an IRA account, you must understand the tax implications and pros and cons of doing so. 

The IRS considers IRAs as retirement accounts, and they will expect you to take withdrawals at some point with a traditional IRA. 

In contrast, there is no up-front taxation which could be advantageous if it’s likely that you’ll be in a higher tax bracket come retirement than when currently working. 

However, there are fewer restrictions on contributions with a Roth IRA because employers typically set contribution limits for 401(k)s. 

Your financial institution may require you to jump through hoops to roll over your 401(k), but the result could be a more diversified investment portfolio providing security for future needs.

That largely depends on what your future needs are. If you're retiring soon with a hefty pension, then it's likely that you won't need to touch the funds again until you need them for retirement purposes. On the other hand, if you plan to continue working for several years yet, it may be wise to move the funds around every couple of months to avoid any penalties levied against your account.
There are advantages and disadvantages to both types of IRAs. With a traditional IRA, you will have to pay taxes on the withdrawal, whereas with a Roth IRA, there is no up-front taxation which could be advantageous if it's likely that you'll be in a higher tax bracket come retirement than you are now. The difference between a 401(k) and an IRA is that with the 401(k) you are restricted by contribution limits because it is an employer-sponsored plan. With an IRA, you are not only able to contribute more, but you can also choose from a wider range of investments because it is your account. Your financial institution will require you to jump through some hoops to roll over your 401(k) into an IRA, but the result could be a more diversified and less restrictive investment portfolio that can better secure your future.
There are several benefits to rolling over a 401(k) into an IRA. For starters, you can contribute more to your IRA than a 401(k) since there are no contribution limits on IRAs. Additionally, the IRA offers a wider range of investments than a 401(k): you are not limited to your former employer's choices. You can rollover a 401(k) into an IRA at any time, but you should do so before the account holder's 59 ½ birthday for tax purposes.
You could end up paying a lot of taxes and penalties if you do not roll over your 401(k) into an IRA account. The IRS considers IRAs as retirement accounts, so they will expect you to take withdrawals at some point with a traditional IRA. In contrast, there is no up-front taxation which could be advantageous if it's likely that you'll be in a higher tax bracket come retirement than when currently working. However, with a Roth IRA, there are less restrictions on contributions because employers typically set contribution limits for 401(k)s.
Yes, you can make an in-service withdrawal from your 401(k) and contribute the funds to a Roth IRA. This will allow you to participate in the tax benefits of a Roth IRA and add to your retirement savings even faster. However, when you do this, the amount you contribute will count towards your deductible contribution for the year.

401(k) Plan | A Complete Beginner's Guide

401(k) Meaning

The 401(k) retirement savings account got its name from the Revenue Act of 1978, where an addition to the Internal Revenue Services (IRS) code was added in section 401(k). Consequently, 401(k) does not stand for anything except for the section of IRS tax code it was created in.

Traditional 401(k) vs Roth 401(k)

There are two types of 401(k) plans: Traditional and Roth 401(k)s. The traditional 401(k), named after the relevant section of the IRS code, has been around since 1978. With this plan, any contributions you make to the 401(k) account will reduce your income taxes for that year and will be taxed when they are withdrawn. Roth 401(k)s, named after former senator William Roth of Delaware, were introduced in 2006. Unlike a traditional 401(k), all contributions are made with after-tax dollars and the funds in the Roth 401(k) account accrue tax free. Typically, employees can take advantage of both plans at the same time, which is recommended among financial advisors to maximize retirement savings. Because of the way the contribution limits work, it is possible to invest different amounts into each account, even year-to-year, so long as the total contribution does not exceed the set limit.

Contributing to Your 401(k) Retirement Plan

Contributing to a 401(k) plan is traditionally done through one’s employer. Typically, the employer will automatically enroll you in a 401(k) that you may contribute to at your discretion. If you are self-employed, you may enroll in a 401(k) plan through an online broker, such as TD Ameritrade. If your employer offers both types of 401(k) accounts, then you will most likely be able to contribute to either or both at your discretion. To reiterate, with a traditional 401(k), making a contribution reduces your income taxes for that year, saving you money in the short term, but the funds will be taxed when they are withdrawn. With a Roth 401(k), your contributions can be made only after taxation, which costs more in the short term, but the funds will be tax free when you withdraw them. Because of this, deciding which plan will benefit you more involves figuring out in what tax bracket you will be when you retire. If you expect to be in a lower tax bracket upon retirement, then a traditional 401(k) may help you more in the long term. You will be able to take advantage of the immediate tax break while your taxes are higher, while minimizing the portion taken out of your withdrawal once you move to a lower tax bracket. On the other hand, a Roth 401(k) may be more advantageous if you expect the opposite to be true. In that case, you can opt to bite the bullet on heavy taxation today, but avoid a higher tax burden if your tax bracket moves up. Check out this article from Forbes to see the IRS tax rate tables for 2020, but remember that they are subject to change. A smart move may be to hedge your bets and divide your contributions between the two types of IRAs. If your employer allows you to add funds to both a traditional and Roth 401(k), then doing so reduces the potential risks of each. In this case, you will also have the ability to decide what proportion of your income goes into each account, meaning that as you near retirement and have a clearer idea of what position you will be in, you can put more into one or the other. When you do decide which avenue to take, make sure to thoroughly evaluate your decision. Moving funds from one account to another, such as from a traditional to a Roth 401(k), is time consuming and expensive, if even possible. Likewise, transferring a 401(k) from one employer to another in the event of a job change is also tricky. You want to make sure that when you put money into your plan, it will be able to sit undisturbed for a very long time.

Pension vs 401(k)

Pensions are similar to a 401(k), but are a liability to a company. If an employer offers an employee a pension, it means that they are promising to pay out a set amount of money to the employee at the time of their retirement. There is typically no option to grow this amount, but it also does not require any financial investment from the employee. Pensions, also referred to as defined-benefit plans, are becoming increasingly rare because it puts the financial burden of offering a retirement fund for employees entirely on the employer. 401(k)s, which are also called defined-contribution plans, take some of the financial pressure off of an employer, while also allowing employees to potentially earn a larger retirement package than they would have with a pension.

How Much Should I Contribute to My 401(k)?

Most financial experts say you should contribute around 10%-15% of your monthly gross income to a retirement savings account, including but not limited to a 401(k). There are limits on how much you can contribute to it that are outlined in detail below. There are two methods of contributing funds to your 401(k). The main way of adding new funds to your account is to contribute a portion of your own income directly. This is usually done through automatic payroll withholding (i.e. the amount that you wish to contribute, counting all adjustments for taxation, is simply withheld when receiving payment and automatically put into a 401(k)). The system mandates that the majority of direct financial contributions will come from your own pocket. It is essential that, when making contributions, you consider the trajectory of the specific investments you are making to increase the likelihood of a positive return. The second method comes from deposits that an employer matches. Usually employers will match a deposit based on a set formula, such as 50 cents per dollar contributed by the employee. However, employers are only able to contribute to a traditional 401(k), not a Roth 401(k) plan. This is especially important to keep in mind if you want to utilize both types of plans. A key variable to keep in mind is that there are set limits for how much you can add to a 401(k) in a single year. For employees under 50 years of age, this amount is $19,500, as of 2020. For employees over 50 years of age, the amount is $25,000. If you have a traditional 401(k), you can also elect to make non-deductible after-tax contributions. The absolute limit, counting this choice and all employer contributions, is $57,000 for employees under 50, and $63,000 for those over 50 as of 2019.

Plan in Advance

Allow us to help you prepare and plan for your retirement ahead. Contact a financial advisor in St Helena, CA or visit our financial advisor page for other details.

401(k) Plan FAQs

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

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