401(K) Rollovers: When, Why, What, Where, and How of it

401k rollover

Heritage Fund Realty and Investments participated in three community events last week and in the process we were able to speak with and answer the questions of many individuals about their financial needs and issues. Over the three events we continued to get questions about 401(k) plans. What should I do with the 401(k) from the job I just left? I am retired or approaching retirement, should I leave my funds in my 401(k) plan? What are my options for moving my 401(k) funds? The list goes on.

Many people are interested or concerned about their 401(k) accounts because for most people the 401(k) is their biggest retirement asset.  For some, it is their only retirement asset. They have been contributing into their 401(k) plan for many years and have accumulated a substantial amount of money. So naturally they want to protected it, continue to grow it, and make sure they are doing the right thing.

This post answers some of these questions. We will answer when and why some people should move their 401(k) and what are some of the options you have when moving your 401(k). These options also work for 403(b) plans or any other qualified retirement plan.


When can your Rollover your 401(k)?

The law allows for you to rollover your 401(k) when you leave your current job. The reasons for leaving can vary:

  • Leave for another job
  • Retire
  • Become unemployed

You may also be able to rollover your 401(k) while you are still working for your current company. This is called an in service distribution or an in service non hardship withdrawal. We will discuss what this is and why you may consider it later in the article.

When you do leave your current job, the money and assets you have accumulated in a 401(k) account (including any company match) belong to you and there are several options available to you for that account.


What can you do with your 401(k) from an old employer?

You have a few rollover options for your 401(k) funds:

  • Cash out and take the money
  • Leave the money in the old employer’s plan
  • Transfer the money to a new employer’s plan
  • Move the money to a Traditional IRA
  • Move the money to a Roth IRA
  • Move the money into an Annuity

Let’s go over each of these options and see why you may choose one or another.


Cash out: 

In this option, you take the money in a lump sum payment and deposit it into your checking out. This is a tempting option, but it is usually not advisable. If you are over the age of 59.5 your account value will be taxed at your current income rate. Your employer will take 20% automatically and send it to the IRS as a pre-payment for taxes so you will only receive 80% to start with. You will owe the rest of the taxes on the current year’s tax return. If you are under 59.5, in addition to everything above, you will be charged a 10% early withdrawal fee. With this option you get the cash in hand, but you lose a significant amount to taxes and/or penalties. You also lose the opportunity for the continued tax deferred growth that you would get from keeping the money in a qualified plan such as another 401(k), an IRA, or an annuity.


Leave the money where it is: 

Your old employer is obligated to allow you to keep you 401(k) funds where it is if the account balance exceeds $3,500. This could be a good option for you if your old plan offers a large amount of quality investment options that you are satisfied with. If your old plan does not offer a good variety of investments, you may be better off moving to an IRA or to your new employer’s plan. Another downside of keeping your money with your old employer is that if you get a new job and a new 401(k), you will now have two plans to manage instead of one. Your 401(k) plan may also suffer from “out of sight out of mind” syndrome and you may forget to give it the care that it needs.


Move to your new employer’s plan: 

This is pretty straight forward. You had a 401(k) plan at your old job and when you leave for a new job you simply move the money from the old plan to your new job’s 401(k) plan. There are no tax consequences here as both plans are qualified. This is beneficial because as you begin to contribute to your new plan you only have one 401(k) account to manage. The reason you may choose not to do this is because your new 401(k) plan is very limited and you would prefer to invest your money elsewhere. You may also be looking to move your money out of 401(k) plans all together and into something with less risk, such as an annuity, or into something with much more investment freedom, such as an IRA which we will talk about next.


Move into a Traditional IRA

Tax wise, traditional IRAs are very similar to a 401(k) plan. They both are funded with pre-tax money, grow tax deferred, and utilize the same 59.5 age rule when it comes to withdrawals and penalties. For this reason it is very easy to roll your 401(k) into a Traditional IRA. Most discount brokerages (Fidelity, Etrade, Tradeking, etc) make it very simple to move your money into a Traditional IRA. There are no tax consequences for moving into a Traditional IRA because they both use pre-tax money. There are also no penalties. Your money can continue to grow tax deferred until retirement and you can continue to contribute to your account ($5,500 per year, $6,500 if you are over 50). The money you contribute is tax deductible. The difference between the 401(k) and the traditional IRA is that the IRA is not controlled by your employer. You are free to invest is individual stocks, bonds, mutual funds, ETF, or anything else that your broker has to offer. This is a great option if you leave your job and do not have another job to go to right away or if you are looking for more freedom and flexibility to invest your retirement money.


Move into a Roth IRA

The law now allows you to roll your money into a Roth IRA. Roth IRAs differ from Traditional IRAs in that the contributions into a Roth are after-tax money. When you contribute to a Roth, you do not get a tax deduction for the contribution like you do with a Traditional IRA contribution. This means that rolling a 401(k) into a Roth IRA is a little more complicated and it triggers tax consequences. You can think of it the same way as cashing out, described above. You will have to pay taxes on the money at the current income tax rate, your company will hold 20% to send to the IRS and if you are under 59.5 years of age, you will owe a 10% early withdrawal penalty. However, the benefit is that once the money is in the Roth IRA it will grow tax deferred and you will not pay taxes on any of the withdrawals once you retire. There are income limits to qualify for a Roth IRA. The current income limits are $178,000/year for married couples and $112,000/year for singles. The reason you may consider moving to a Roth IRA is because you feel taxes are going to be higher in the future and you would rather take your tax hit now.


Move money into an Annuity

You may choose to roll your 401(k) money into an Annuity. A rollover annuity allows you to move your money out of the stock market and into an annuity account There are two types of annuities: Immediate and Deferred. An Immediate annuity begins to pay you income each year for the rest of your life. The amount is based on the amount you roll over and your age. A deferred annuity allows you to continue to invest and grow your money. Then you can choose to annuitize it and start receiving payments at a later date. If you are rolling over your 401(k) money you are most likely looking to roll it over into a deferred annuity. The benefits are that there will be no tax consequences for the rollover and your money will continue to grow tax deferred. However, the money will no longer be invested in mutual funds, stocks, or bonds. The annuity company will allow you to invest the money into a few different accounts. One will be a fixed account that pays a rate of interest each year (somewhere between 3 and 6%). The other accounts will be some combination of indexed accounts. These accounts follow the performance of the stock market. The caveat with these accounts is that they are capped (somewhere between 13% and 15%). This means that you only get to participate in the first 13 or 15% of the market move upward. The trade off for this cap is that the accounts are capped on the downside too (either 1% or 0%). These means is the market goes down, your account will not lose money.

The reason people choose to move their retirement money into annuities is because they want their money to grow with the stock market, but they do not want to risk losing their principal amount. This is a good option for people approaching retirement or who are already retired. When you are approaching retirement, you do not have time to make your money back if the stock market takes a down turn. The downside is that annuities have penalties called surrender charges if you want to cash the whole thing out before a certain amount of time. Surrender periods vary but they are usually around 5 to 7 years.

One last thing to say about annuities; Most people do not like annuities because they do not like the thought of handing over a lump sum of money in exchange for yearly payments. This is a valid concern and the annuities companies have changed the structure to combat this concern. Now, with the implementation of income riders, annuity owners are able to start and stop payments whenever they want, have control over the lump sum of money, and even pass down the money inside an annuity to their heirs.


So that is a rundown of your options for moving your 401(k). We talked about these options in terms of what to do if you leave your current job. What if you want to move your 401(k), but you are still working at your current job? This might happen if the investment options in your 401(k) are really bad, if you are approaching retirement and you want to move into an annuity, or if you just want more flexibility in your investments. There is a way to rollover your 401(k) into one of the options above while you are still working for your employer. It is called an in service distribution.


In Service Distribution 

Most employer 401(k) plans have a provision to allow you to move your plan into another account while you are still currently working. It is just not publicized. In order for you to be able to do this, you would have to contact your plan administrator and ask what the rules are for an in service distribution. Usually the plan will not allow it until an employee is 59.5 years of age or over, but some will allow for it before this age. If you like your job, but not your 401(k) plan, this may be an option to look at.


We went over a lot in this article and it may seem like a lot to take in. The reason we give so much information is because we want you to be well informed about your financial options and we always want you to have a resource to come back to if you want to know more.

Our advisors at Heritage Fund are here to help you navigate these decisions and can help you with actually moving your money once a decision is made. Our financial planning and advice is available free of charge so it doesn’t hurt to call. If you would like help with 401(k) rollovers or if you have any other financial questions contact us at info@heritagefundrealty.com or 510-269-7406