Rolling an old 401(k) into an individual retirement account right after leaving your job sounds like a smart move to simplify your finances. But while some rollovers make sense, it’s important to consider all your options to avoid tax headaches, lost benefits and higher fees.
Here are three questions to ask yourself before you make the switch.
1. What am I giving up by leaving the old 401(k)?
Keeping your money in the 401(k) account of a previous employer isn’t necessarily a bad idea. If your old plan has low fees and strong investment options, it may be beneficial to keep the account intact instead of rolling it over to an IRA or your new employer’s retirement savings account.
The age 55 rule also plays a role. It states that someone can withdraw money from a 401(k) plan penalty-free at 55 if they left their job in or after the year they turned 55. In that case, you can withdraw from a traditional 401(k) while enjoying lower tax rates if you don’t have a salary. This option is not available for IRAs, and you must wait until you turn 59 ½ to avoid penalty fees.
Make sure you understand the pros and cons before you commit to a 401(k) rollover. Just because you left your employer doesn’t mean you should rush to move funds from a 401(k) to an IRA or another account.
2. Will I pay higher fees?
A rollover may be the easy path to simplifying your finances, but some rollovers are costly. Fees can vary, and for 401(k)s, you should consider the investment options.
A 401(k) rollover can make sense, especially if your old plan has excessive fees. In that case, you can save a lot of money with a rollover, but you must compare several IRAs before committing to the right one, or thoroughly research the pros and cons of a new employer’s 401(k) or similar plan.
3. How will this impact taxes?
You can avoid some complicated tax-related questions by doing a direct rollover. This type of rollover involves money moving directly from the 401(k) plan to your new plan.
There’s often more to consider with an indirect roll over. If the check is made payable to the worker, the IRS has a 60-day deadline for that worker to move those funds into another retirement account. If you do not make the deadline, the IRS treats the traditional 401(k) funds as ordinary income and applies a penalty fee if you are under 59 ½, unless an exception applies.
You can still end up with higher taxes if you roll over a traditional 401(k) plan to a Roth IRA. The conversion is treated as ordinary income for tax purposes, but qualified Roth IRA withdrawals can be taken tax-free.
