How to spend a 401k in an IRA


We want to help you make better informed decisions. Certain links on this page – clearly marked – may direct you to a partner website and earn us a referral commission. For more information, see How we make money.

One of the most common benefits of working for an employer is the company sponsored 401 (k) plan. But what happens to that money when you quit your job?

If you’ve changed jobs a lot, there’s a good chance you already have some floating 401 (k).

When you leave a business, you will have several options for what to do with your 401 (k) plan. Since most 401 (k) plans are set up for employees to contribute pre-tax dollars and then refrain from withdrawing money until they are at least 59 and a half years old, you should try to avoid early withdrawal fees no matter what you do.

Here’s how to go from a 401 (k) to an IRA and how to decide which option is best for you.

Keep your current 401 (k) plan

First of all: whatever you do, don’t take the money out. This means cashing out your 401 (k) and depositing that amount into your checking account and using it for other expenses. It’s a bad idea. If you do, you will be hit with an IRS penalty, and the money will count as income that increases your federal taxes for the year. While this can be tempting, try other options instead.

One of the simplest things you can do instead is to just leave your current 401 (k) balance where it is, even though you won’t be able to make additional contributions.

This option may be suitable for someone who is happy with the fees and performance of their current 401 (k) plan and who does not have another retirement account to transfer the balance to.

But this option might not be the best because in a decade or two you could have a handful of 401 (k) plans with past employers, making them easy to lose sight of and difficult to manage.

Also, not all employers allow you to keep your 401 (k) open after you leave. Some may have a minimum balance requirement or require you to relocate your retirement funds to a new account with the same investment manager.

It may also depend on the size of your employer. Large companies “don’t mind having additional participants in their plan,” says Mark Deering, CFP and senior executive vice president at Southwestern Investment Group. “Smaller plans will often try to force plan members out of service to avoid having their plan audited or facing higher administration costs. “

Transfer your 401 (k) to an IRA

Another option when you leave a job is to transfer your 401 (k) balance to an IRA – or an individual retirement account. An IRA is also a tax-advantaged retirement account, but rather than being sponsored by an employer, it is self-directed.

One of the main reasons someone might choose to move their 401 (k) to an IRA is the greater variety of investments available, says Lazetta Rainey Braxton, Certified Financial Planner and Co-Founder of Financial Planning Company 2050 Wealth Partners,

“With the rolling IRA, you have more options in terms of investments, whereas with a 401 (k) employer, it is up to the employer to determine what the investment menu is,” says Braxton .

If you already have an IRA, you can often transfer your 401 (k) balance to your existing account. If you don’t have an IRA yet, you’ll need to open one before you can start the transfer.

Once you have an IRA, contact your former 401 (k) plan administrator and let them know that you want to roll over the balance. They may require documents completed by you or your IRA provider.

Rollover will occur in one of two ways:

  1. The 401 (k) administrator may be able to send the money directly to the IRA provider, who will then deposit it into your account.
  2. Or, you may receive a check with your 401 (k) balance, which you will then need to deposit into your IRA. You must do this within 60 days or the check will be considered a withdrawal, resulting in an early withdrawal penalty and income taxes. Many brokerages have user-friendly interfaces that allow this process to be done digitally by simply taking a photo of the check and depositing it into the account.

Switching from your 401 (k) to a traditional IRA vs. a Roth IRA

You have the option of transferring your 401 (k) to a Traditional IRA or a Roth IRA. One is no better than the other, and ultimately it is up to you and your investment goals.

However, there are a few things you need to worry about, and the main difference is: Roth IRAs require after-tax contributions. If you roll over money from a traditional 401 (k) then you did not pay taxes on that money because it came from your paycheck before you received your paycheck. As a result, transferring your traditional 401 (k) balance to a Roth IRA will require you to pay taxes on the entire balance in the year you roll over. It could mean thousands of dollars in taxes. So just be careful about it.

However, it’s easier to turn a traditional 401 (k) into a traditional IRA because both contain pre-tax dollars. You don’t have to worry about triggering a taxable event.

On a related note, a Roth 401 (k) and a Roth IRA are both funded with after-tax dollars, which means that integrating one into the other would not require a payment of tax.

Paying income taxes by moving a traditional 401 (k) into a Roth IRA isn’t necessarily a reason not to: Roth IRAs can be a powerful retirement savings tool, and some investors may prefer pay the tax bill now for the benefit of withdrawing the money tax free during retirement.

But whatever decision you make, it’s important that you understand the consequences and have your budget ready.

Switch to a new 401 (k)

If you are moving to another employer that also offers a 401 (k), you may want to consider transferring your balance to the new company. The advantage of this option is the simplicity – you will only have one retirement account to follow, rather than multiple accounts.

In most cases, this type of rollover can be as easy as filling out a few online forms, and the companies that handle your 401 (k) can usually take care of things on their own.

“This process is most often initiated by receiving 401 (k) plan documents,” says Deering. “For example, if my 401 (k) was at T. Rowe Price and I wanted to roll over an old 401 (k) plan I had at Fidelity, I would contact T. Rowe Price to get their renewal documents and submit them. to Loyalty to distribute the check.

Cash in your 401 (k)

When you quit a job it can be tempting to cash in the 401 (k), but it should only be done in extreme circumstances. Not only will you rob your future self of your retirement savings, but you will lose a significant amount of value.

When you withdraw your 401 (k), you have to pay income taxes, as well as an additional 10% early withdrawal penalty. You could easily lose 30% of the account balance in taxes and fees.

Additionally, cashing in your 401 (k) now reduces the amount of money you will have in retirement. Until that money is in the market, it doesn’t grow.

Be careful not to convince yourself that you can replace it later. With compound interest, time makes all the difference. The more time your money is invested, the more potential it has to become a comfortable retirement nest egg.

“It’s rarely the best thing to do,” says Deering. “It takes a lot of effort, time and resources to save for retirement, and every dollar counts. “

How to decide which rollover is right for you

When you leave an employer, you will need to decide whether you want to leave your 401 (k) in place, transfer it to an IRA, or transfer it to a new 401 (k).

First, consider the fees charged by each plan. If you find that your old business fees are higher than what you would pay in your new business or in an IRA, then it makes sense to roll over your balance. Moving money to an IRA can be an effective way to save on fees – some online brokerage firms offer 0% expense ratios on index funds.

Pro tip

When deciding what to do with your 401 (k) balance when you leave a job, consider factors such as the return on your investment so far, the fees charged by your plan, and the variety of investment options that available to you. Compare these factors with your new employer’s 401 (k) or IRA to decide which plan is more attractive.

Also consider the investment options available to you. 401 (k) plans usually come with a selected list of investments you can choose from, while an IRA offers many more options. Some investors may prefer to have more options, while others may find it overwhelming.

“You have to be comfortable making these choices or working with a planner or financial advisor who can also advise you,” says Braxton.

That being said, investors who wish to transfer their 401 (k) to an IRA and are not comfortable choosing their own investments may also consider a robo-advisor, who chooses investments on your behalf based on your time horizon. time and your financial goals. Robo-advisers are a great way for all investors to take charge of their investment.

What to do with employee actions

If you have employee shares through your former employer, you will also need to decide what to do with those shares. For stocks you already own, Deering advises you to sell those stocks. At the very least, make sure stocks don’t represent a disproportionate percentage of your portfolio, as can sometimes happen with employee stocks.

According to Deering, the main consideration is whether there is anything stopping you from selling the stock. In some cases, there may be lock-in periods that prevent you from selling your shares for a period of time. And if you’ve owned the stocks for less than a year, then it makes sense to hold them until the one-year mark when you’re eligible for long-term capital gains tax treatment.

If you have any stock options left, they will likely expire within three months of leaving the company. Whether you choose to exercise them should depend on the current price of the stock relative to the price at which your options allow you to buy them, as well as how much of the company’s stock you already have in your portfolio.