The 401(k) Rollover Explained

Are you planning to, or have you recently left or lost your job where you had a 401(k)? The good news is that since these accounts are tied to your employer, once you cut your ties with that employer, you’re generally entitled to do what you wish with those funds. Unfortunately, a lot of people take unnecessary losses and penalties by withdrawing the funds. This can set your retirement back years, and tens of thousands of dollars. So, the best option is to opt for a 401(k) rollover.

The 401(k) rollover is ideal because it allows you to transfer your existing retirement account into another retirement account without being subject to unnecessary taxes or withdrawal penalties. Remember, retirement accounts like a 401(k) are funded with pre-tax dollars, and grow tax-deferred. That means if you take a premature distribution, the IRS is going to stick you with taxes on all of that money, and also apply an additional 10% penalty if you withdraw the money prior to age 59 1/2. This is a pretty raw deal if you don’t need that money for a dire emergency, yet so many people will take the penalty simply because they don’t know how to do a rollover.

Your Rollover Options

The first decision you need to make when it comes to rolling over your 401(k) is where you want to roll the money to. There are three primary options that I’ll discuss here and provide some of the benefits and drawbacks of each.

Rollover Into New Employer’s 401(k)

If you find new employment and they also offer a retirement plan such as a 401(k) or 403b, in most cases they will allow rollovers into your new account. But is this a good idea?

Pros: The benefit of rolling into your new employer’s 401(k) is that it doesn’t matter how much money you have since there are generally no investment minimums on the fund options. If your rollover isn’t that much, you may find that you don’t have enough money to properly diversify your money with a particular mutual fund company. In some cases, you need a minimum investment of $3,000 just to invest in a single mutual or index fund at a fund company. If your 401(k) balance is low, say $5,000, it will be harder to diversify that money than if you were to move it into the new 401(k) where you could spread the money out regardless of how much you have to invest.

Cons: Aside from that primary benefit, there are also plenty of drawbacks. First, is that you’re losing a lot of flexibility. Remember, these are employer-sponsored accounts, so as long as you’re an active employee, you’re bound to that plan and its rules. This means you’ll be stuck with whatever investment choices they offer, and will not have access to your funds again unless you want to take a loan (if it’s allowed) or you terminate employment.  In addition, a lot of 401(k) plans have relatively high fees. This is especially true for smaller employers. You could find that you’re paying on average 1% or more for each investment when you could easily find a comparable investment outside of the plan for half that.

Rollover Into a Brokerage IRA

Another common option is to roll over your 401(k) into a brokerage IRA account. This can be done at almost any financial institution, but most often people flock to the discount brokers where trades have low or even no commission.

Pros: Brokerage accounts provide the ultimate flexibility. In a 401(k) you’re typically bound to just mutual or index funds. This is great for most people, but there are a lot of other investment options out there. The biggest benefit in a brokerage account

So, if ultimate flexibility is what you’re looking for, a brokerage IRA is going to provide it.

Cons: Even though there are many great benefits with this option, there are obviously going to be some drawbacks as well — the biggest being cost. Unlike investing in most mutual funds that just have a built in expense ratio, with a brokerage account you’re going to be charged a fee each time you place a trade with most brokers. And if you trade an ETF, you’re also dealing with recurring expenses built into the fund on top of the trade commission. Also, some brokers will charge a transaction fee to place a mutual fund trade that you otherwise wouldn’t have inside a 401(k) or if you had an account directly with the fund company.

Rollover Into an Mutual Fund Company IRA, Annuity or Fractional Life Settlement

The third main option for rolling over your 401(k) is to roll it directly into an IRA.

Pros: Rolling directly to a fund company will typically be the cheapest way to invest in their funds. There are no commissions, and in most cases, no account fees if you meet some basic requirements. It can also be helpful to stick with one provider so it’s easier to keep track of your investments.

Cons: If flexibility is what you’re after, this may not be your best option. For one, you’re basically tied to this fund company’s offerings. While most fund companies will have plenty of options to satisfy most investors, if you want to dabble in individual stocks, ETFs and so on, you’ll more than likely need to then open a separate account with a brokerage to do this. In addition, you have investment minimums to contend with. All fund companies are different, but most require that you have anywhere between $500 and $3,000 to invest in a single fund before you can buy any shares. For smaller accounts, this might mean being unable to invest anything, or only buy one fund until you save up more money to invest in another.

Your Rollover Step-by-Step

So, you’ve decided that you’re going to do your retirement savings a favor and roll over your 401(k), but where do you get started? Don’t let the process intimidate you. Sure, there may be some complicated looking forms to fill out and it might mean that you’re dealing with your life savings, but it isn’t hard if you know the steps involved.

1. Check Rollover Eligibility With Your Old 401(k) Provider

Before you do anything, check with your old provider. You want to make sure there won’t be any unexpected snags or fees and make sure that you’re showing up as a terminated employee. They can’t release the funds unless you’re terminated, and I’ve often seen cases where your employer doesn’t notify the plan provider, and you’re still flagged as an active employee in the system. Then when you try to do the rollover, it doesn’t go through, you’re not often told why, and it is up to you to make the contacts to get that resolved. So, save yourself some time and make sure you are cleared to move the money and that there are no unexpected penalties, fees, or restrictions.

2. Obtain Rollover Forms From Old Provider

If you’re already on the phone with the old provider checking to make sure you are free to move the money, you can also use this time to ask for the required paperwork. In most cases, you will need to submit paper forms in order to initiate a rollover, so you’ll want to tell them that you intend to roll the money over, and that you want the forms needed. They will either send them to you in the mail, or you may be able to request them via email or by fax. There are some providers that will only require a rollover request form from your new plan, and if that is the case, simply move on to step 3.

3. See What is Needed for the New Provider

Next, you’ll want to check with your new account provider to see what they require in order to accept the rollover. Whether it’s a new 401(k), brokerage account, or mutual fund company, each will have their own unique, but similar process.  In some cases, you may be required to open up an account first, and then submit a rollover form. In other cases, the account creation and subsequent rollover may all be part of the same form or process. Either way, determine how they require it to be done, and make sure you have all of the appropriate information from the previous provider to complete everything.

4. Complete the Forms Properly

This is an important step, especially if you’re doing it on your own. All of these forms may have a lot of information, and to make sure things go as smoothly as possible, you’ll want to make sure you fill it out correctly. For instance, if your rollover form from your previous carrier asks what type of distribution this is, you want to be sure to choose a Direct Rollover. This ensures that the funds are made payable to, and go directly to the new account. This often requires information as to how to make out the check or where to wire the money. This is information that you’d need to obtain from the new provider.

If you have questions at this stage, call the company and ask for help. Whether it’s questions with your outgoing provider or incoming, don’t assume and just fill it out the best you can. Sometimes just an unchecked check box, or an overlooked signature can kick the forms back and delay the process for weeks. In the worst situations, you aren’t even informed there is a problem and it can drag this process out forever. So, save yourself some trouble and make a quick call if you have questions.

5. Submitting the Forms and Follow-up

Once completed, it’s time to submit the forms. Whether it’s forms for both providers or just the new one, you’ll need to mail or fax them to the appropriate location. But your job doesn’t stop there. You need to stay on top of this process. There is a nasty habit of outgoing providers to make it difficult for people to pull their money out. If something is wrong with one of the forms, or they never receive anything, you aren’t always going to get a call or letter right away alerting you. They don’t want to see those funds leave, so they aren’t going to be quick to tell you something that will speed that up. So it’s up to you to follow up on your own in most cases. If you haven’t received your check, or the funds haven’t been deposited after about two weeks, I’d make a few calls and make sure all parties received the appropriate paperwork and that they are in good order. If not, you may need to have them send the forms back so you can correct the error, or simply provide some information over the phone. Either way, don’t assume that everything is going smoothly behind the scenes if you don’t hear anything.

In many cases, you will receive a check for the full amount of the rollover in the mail. It is then up to you to make the deposit into the new account. Make sure the check is made out properly, and submit it for deposit with any required deposit forms. If you previously called and they said a check has already been issued and mailed, keep an eye out for it. Again, you want to be on top of things if it doesn’t show up so that you can have a stop issued on the check and a new one sent. And don’t hang on to the check once you receive it. Get it deposited as soon as possible and out of your hands so that you don’t forget about it, it gets lost, etc.

Making the Right Choice

As you can see, there are many different options available to you when it’s time to do a rollover. There isn’t a right or wrong answer, as each method has its own pros and cons. So, don’t become paralyzed by the choices or process, because the worst thing you can do is withdraw the money unnecessarily. Obviously, there may be some financial emergencies that may dictate a rollover isn’t the best course of action, but for most people, this will go a long way in helping you achieve your retirement goals.