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How To Rollover a 401k

If you’re looking to transfer the funds in your Retirement Account into a new 401k, there could be a chance that you’re confused. If you have no idea how to go about it, then this article is for you. We are going to look at the best way to rollover a 401k with minimal stress. We will show what rolling over is, how to get it done, and the advantages or disadvantages of rolling over.

What Is a 401k?

According to subsection 401(k) of the Internal Revenue Code, a 401k is the retirement account into which pre-tax salaries are paid. All 401ks are employer-sponsored. These funds are in turn, put in several investment vehicles like stocks, bonds, futures, mutual funds, and cash.

How Does a 401k Work?

To make sure that the employee has a designated retirement fund, the employee chooses a percentage to be deducted from his paycheck. In turn, the deducted funds are put into his 401k for retention and/or investment. Again, it is up to the employee to choose the manner and form in which the funds are to be invested.

Depending on the specifics of the account, funds might be tax-free. The employer might also make matching contributions. We generally advise that you contribute the maximum amount allowed, or a sum close to it. For those who do not know, there are immense benefits that come with having a 401k account. They include:

Matching Contributions From Your Employer 

If you like free money, then this one’s for you. There are cases in which your employer will choose to match your contributions to your 401k. They may choose to do it dollar for dollar, or fifty cents to the dollar, up to a designated threshold. 

Let’s say you make 70,000 dollars yearly. Your employer offers you a 50% match up to a 10% limit. This means that if you contribute 7,000 dollars to your 401k (10%), then your employer will pay 3,500 dollars. In essence, you’re earning 3,500 free dollars. 

It is up to the employer to decide how to match, but many companies choose to match dollar for dollar. 

Tax Breaks

Many believe that tax breaks are the icing on the cake when it comes to 401k accounts. Let’s show you how. First of all, the contributions you make to your 401k are pre-tax. That means that you pay into your 401k before you are taxed on your income. 

In turn, your 401k funds are not taxable until you access them upon your retirement. Your earnings from your 401k are also not recognized as income. This means that your funds will be in a lower tax bracket which consequently resulting in lower rates. 

Finally, 401k funds are tax-deferred. This means that whatever investment vehicles they are put in, cannot be taxed. However, this only applies if the funds are still part of the plan. The deferred tax plan will allow your earnings to exponentially grow. In essence, your money makes you more money, and there’s no taxation for it. 

Safe From Creditors 

If you fall into debt, you do not need to worry. Rest assured that whatever Chapter 7 or 11 proceedings you’re in will not get to your 401k (even if it gets that bad). This is because the Employee Retirement Income Security Act of 1974 (ERISA 1974) does not allow such. In essence, you’re safe in the arms of the Law, away from your judgment creditors.

Ordinarily, a pertinent question to ask at this time is: What will happen when I change jobs? Is my 401k safe? The answer is yes. Your 401k funds are safe, however, there are options. You can choose to withdraw your funds. That is not advisable because as soon as you do so, the tax will accrue. Income tax and a 10% withholding fee will accrue, and I’m sure you don’t want that.

A better option is to rollover your 401k funds into a new 401k under your new employer. You can also roll over funds into an Individual Retirement Account (IRA). 

Are you wondering what exactly rolling over means? We will answer that question in the next section.

What Does It Mean to Rollover a 401k?

A rollover is the transfer of 401k account funds from the old one into a new one, or an IRA account. Under the law, this must happen within 60 days from the day of withdrawal from the old account. Several things about your 401k account have to do with your management approach. 

You could be a DIY account manager. This means that you make all the financial decisions without consulting any external parties. Otherwise, you can adopt the external management approach. That means that you allow professionals to safely manage your 401k accounts.

Can You Rollover Your 401k Anytime?

You can commence your rollover at any time. However, once you do so, you must complete the process within 60 days. That means that you should have rolled over into a new 401k or an Individual Retirement Account within that time frame.

What Happens if You Miss the 60 Day Mark?

First off, the 60-day Rollover Rule does not apply to every Rollover transaction. It can only apply where there is an indirect Rollover. An Indirect Rollover means that the funds from your 401k were paid to you, then you transferred it onward. By setting the Rollover Rule, the aim was to ensure that taxes apply as and when due. You are given 60 days to do the needful. When you fail to do so, then taxes will apply to you as is supposed to.

A good thing to do to avoid a situation like this is to engage in a Direct Rollover. What this means is that your 401k funds will be transferred directly to your new 401k or your IRA account. A check will be cut directly to your IRA or your new 401k. As a result, you will have no rollover deadlines to worry about.

What To Do About Your 401k With a Previous Employer

In situations where you are between jobs, the transition can be a lot to deal with. One of the problems you may encounter is your now-old 401k account and what to do with it. Here are different options for decisions to make in this regard.

Cash Out

One of the main options is to cash out immediately. You can cut a check and put the money to use. However, we do not recommend this because any withdrawal you make from your 401k attracts a 10% withholding tax charge. This is in addition to the normal income tax which will accrue. 

Under the Law and by convention, the age requirement to withdraw your 401k is 59.5. Any withdrawal made earlier than that attracts taxation, and I’m quite sure it’s not in your plan.

Roll It Over to New Employer

Another option to explore is to roll it over to a new employer. You can do that by direct or indirect rollover methods. You either choose to withdraw the money in your name, and deposit it in a new 401k account, or you could ask that the funds be transferred directly to the new 401k. When you do this, you’re avoiding the application of the 60-day Rollover Rule. 

Keep It With Your Previous Employer

In cases where you leave your job for a new one, you can choose to leave your old 401k with your former employer. However, that will happen without a few conditions. You must have a certain financial threshold. That means that there is a balance expected to be in your 401k. 

If you contributed less than $5,000 to your 401k, they have the right to discontinue. This is because there are coats that come with managing your account. They can cut you a cheque and then you can deposit it in a new 401k account.

Roll It Over to a Traditional IRA

You can also choose to roll over to a Traditional Individual Retirement Account. That way you can take advantage of the multiple options available. It has more perks than a 401k, but will we talk about that in the coming sections.

Important Things to Know Before Rolling Over to an IRA

For you to make that transition from your old 401k to an IRA, there are things you must bear in mind. The IRA allows for more width in deciding on investment options. It offers a more diverse portfolio for investment. We shall now look at the advantages and disadvantages of rolling over to an IRA.

Advantages

  • Diverse Investment Options
  • Lower Account Fees. In some situations, some IRA accounts charge no account fees at all
  • It allows for early withdrawals

Disadvantages

  • IRA accounts do not allow for borrowing. In comparison, 401k accounts do
  • You can only rollover once every year. This in itself can be unfair most times. This is because people who may work more than three jobs will be stuck as a result

Should You Rollover Your 401k or Just Keep It?

Many people have asked this question lots of times, and it is not out of place. If you’re ever split between the two options, your choices should depend on your instant situation. Perhaps, if your threshold in the old 401k is healthy and you want to keep it, then that works. If it isn’t, then you need to roll over to a new 401k. There is no wrong decision in this regard. You only need to do what works for you.

What Happens If You Don’t Rollover?

If you do not roll over to a new 401k or IRA account, you can choose to keep the old 401k you have. You can do that if you met the financial limit for a contribution before you left your old job. When withdrawing your funds from the 401k, you will be charged a 10% withholding tax fee. Other taxes will still apply.

Bottom Line 

Rolling over a 401k account is not rocket science. It is a simple process meant to help you continue to build towards your dream retirement. To maximize the benefits from this process, you should consult your Financial Advisor for informed decisions. 

A financial advisor helps employers to both develop and maintain a plan that suits their needs. They also help employees make important decisions about saving for retirement.