401(k) Rollovers – FAQs for Retirement Investors

When you leave a job, you can have up to three options for your 401(k) account if you want to keep growing the savings tax-free until retirement: leave it in your old 401(k) plan, roll it to a new employer’s plan, or roll it to an IRA. While a rollover might seem like the obvious choice, leaving your savings in the old plan could sometimes mean more savings in the long run. 

Making smart decisions about rolling over your 401(k) is crucial because the fees and investment options can vary widely between different plans and IRAs. This FAQ is designed to help you make the best decision for your financial future.

What Is a 401(k) Rollover?

A 401(k) rollover involves transferring funds from a 401(k) plan to another retirement account, such as a new employer's 401(k) plan or Individual Retirement Account (IRA). The rollover process allows you to maintain the tax-deferred status of your retirement savings.

What Are the Types of 401(k) Rollover?

You can rollover funds from an old 401(k) plan to a new 401(k) plan or IRA either directly or indirectly. The direct method is more common and less complicated.

• • Direct rollover – Funds are transferred directly from your old 401(k) plan to a new 401(k) plan or IRA without any immediate tax implications.
  • Indirect rollover: Funds are distributed directly to you and then you deposit them into a new 401(k) plan or IRA within 60 days to avoid taxes and potential penalties. The taxable portion will be subject to 20% mandatory tax withholding. To defer tax on the entire taxable portion, you must add funds from other sources equal to the amount withheld.

Who is Eligible for a 401(k) Rollover?

A "distributable event," such as termination of employment, must occur before you can rollover a 401(k) account. Distributable events can vary by plan and are detailed in the plan’s Summary Plan Description. Only "eligible rollover distributions" can be rolled over. Most 401(k) distributions meet the definition except for the following:

• • Required Minimum Distributions (RMDs) 
  • Hardship distributions 
  • Withdrawals electing out of automatic enrollment. 
  • Distributions necessary to correct failed ADP/ACP, 402(g), 415(c), and plan limits testing. 
  • A distribution that is one of a series of substantially equal payments. 
  • Loans treated as a distribution.  

Why are 401(k) Rollover Decisions Important?

To maximize your retirement over time, you want to invest your savings in a 401(k) account or IRA with three features:

• • Minimal Fees: The cumulative effect of 401(k) fees can dramatically erode your savings over time.  As such, you want their amount as low as possible. 
  • (At Least) Index Fund Returns: active funds and index funds are the most common investments offered by 401(k) plans and IRAs.  Active funds try to outperform their market benchmark (e.g., S&P 500), while index funds try to match it.  Despite their investment objectives, index funds tend to outperform “comparable” active funds (i.e., funds with a similar benchmark) over time, net of fees.  Your retirement savings should earn no less. 
  • Professional Advice: Maintaining a proper asset allocation when saving for retirement is important. Otherwise, you could miss out on gains by investing too conservatively when young or sustain unrecoverable losses by investing too aggressively when older. Professional investment advice can make this job easy.  Most 401(k) plans and IRAs offer at least one of the three basic forms.   

A 401(k) or IRA with these features could add tens of thousands of dollars of compound interest to your future saving compared to a 401(k) or IRA with excessive fees and underperforming active funds. You don’t want to settle for less when considering a 401(k) rollover.

What Are the Differences Between 401(k) Plans and IRAs?

What are the Rollover Rules for Roth Contributions?

Roth contributions are subject to stricter rollover rules than traditional (pre-tax) contributions. A Roth account can only be rolled to a Roth IRA or 401(k) plan that permits Roth rollovers.   

How Do I Choose Between my 401(k) and IRA Options?

You can have up to three options for your savings when you are eligible for a 401(k) rollover.  The best option for you will depend upon the investments and features you want and the cost of your options: 

Leave Your Savings in the Old 401(k) Plan

Choose this option under the following circumstances: 

• • You like the plan’s investment options. 
  • The plan has low fees. 
  • You want to move the savings to a new employer’s plan later. 

If you have a small balance, this option may not be available.  Some plans include a force-out provision. If your balance is below your plan’s force-out threshold, your former employer can involuntarily roll your savings to an IRA on your behalf. 

Rollover Your Savings to a New 401(k) Plan 

If your new employer’s 401(k) plan permits rollovers, you may want to consider moving your savings to their plan under the following circumstances: 

• • The new plan has better investment options. 
  • The new plan has lower fees. 
  • You want to consolidate your retirement savings into one plan. 

Rollover Your Savings to an IRA

Choose this option under the following circumstances: 

• • The IRA has better investment options. 
  • The IRA has lower fees. 
  • You want to consolidate your retirement savings into one IRA. 

You’re Ready to Make a 401(k) Rollover Decision!

This month, the U.S. Government Accountability Office (GAO) released a report to Congress examining the effectiveness of the 402(f) notice - which 401(k) plans must provide to terminated participants to explain their distribution options. Among other things, the report found that nearly 60% of terminated participants who rolled over their savings to a new 401(k) plan or IRA were unaware they could have left their savings in their old plan.  

This confusion could cost an investor dearly in retirement if they roll their savings from a low-cost 401(k) plan to an overpriced plan or IRA. Our FAQ is designed to help you navigate these decisions and make the best choice for your financial future.