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Geeky Insight:

Ultimate Guide: 401(k) Rollovers and Rollover IRAs

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Written By: DollarGeek

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Retirement can be an overwhelming reality for most Americans.

Nearly 15% of American adults have no retirement savings, and another 22% have less than $5,000 saved for retirement.

Adding to the worry is the fact that over half of Americans (52%) dip into their retirement savings before reaching the qualified retirement age. Not only does it limit their ability to retire comfortably, but they end up paying taxes on these withdrawals.

If you have switched a job or want more control over your retirement plan, a 401(k) rollover is the first step you need to perform.

We have created this guide to help you understand the entire process and offer advice on managing your investments better.

What is a 401(k) rollover?

A 401(k) rollover is when you transfer your current retirement savings from a 401(k) plan to a new retirement account. And, you do it as per the instructions of the IRS, with a timeline of 60 days.

You can rollover funds from a 401(k) to an IRA, SD-IRA, Roth IRA, and any other qualified retirement plan. Here is a link to the IRS Rollover chart for more clarity on eligible rollovers.

5 Steps to rollover your 401(k) to an IRA

Step 1: Choose a retirement account to rollover your 401(k).

The first step is to choose a retirement account for your 401(k) rollover.

There are plenty of options including a traditional IRA, a self-directed IRA, Roth IRA, Roth 401(k), and even a Solo 401(k) if you’re taking up freelancing or contractual work.

The tax treatment of your retirement funds will vary depending on which account you rollover your funds into. For instance, if you’re transferring funds from a 401(k) to a Roth IRA, you’ll pay the due taxes upfront.

Step 2: Open your new retirement account.

Now that you know what kind of retirement account you want to open, the next question is, how do you want to manage your retirement funds?

There are two approaches to manage your retirement account:

Hands-on approach

If you have a fair understanding of finances and hold the required knowledge to manage your retirement accounts, a DIY retirement account is the best way to manage your funds.

You can choose among:

  • IRA account
  • Roth IRA account
  • Self-directed IRA accounts

At DollarGeek, we analyze retirement accounts from different financial institutions before sharing them with our readers.

Here is a list of some of the best IRA account providers in the market.

If you’re planning to open a Roth IRA for tax-free withdrawals in the future, we have something for you as well.

Check out these Roth IRA account providers.

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Hands-off approach

Under the hands-off approach, you leave the job to professionals. It could be human financial advisors or automated investment advisors, aka robo-advisors.

These are managed retirement accounts. Ideally, if you don’t feel comfortable calling the shots for your retirement investing, this is a better approach.

At DollarGeek, we did a thorough analysis of robo-advisors, automated investment advisors that use algorithms to manage your funds, and here is a list for you.

Robo advisors create personalized retirement portfolios at a fraction of the cost you would, otherwise, pay to a human advisor.

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Step 3: File a direct rollover application with your current employer.

For those planning to transfer their funds to the new retirement account through a direct rollover, simply give a rollover application to your employer along with necessary documentation.

Most employers will transfer your funds directly to your new account. If your new account provider has issued specific instructions for a rollover, share them with your employer.

Step 4: Deposit funds within 60 days in case of an indirect 401(k) rollover.

In case you choose an indirect rollover, which means you withdraw funds from your retirement plan and deposit it yourself to the new retirement account, there is a 60-day window.

Also, your employer will withhold 20% of your retirement fund to cover for taxes. You can claim it as tax credit once you complete the rollover.

The IRS allows one indirect rollover in a year, so you want to be cautious.

If you fail to deposit funds within the 60-day window, the IRS will consider it as a withdrawal and charge a 10% early-withdrawal penalty along with regular income taxes.

Step 5: Start picking investments for your retirement portfolio.

Finally, once your 401(k) rollover is complete, you can start picking investments for your portfolio.

If you’re working with a financial advisor or investment management company, their designated professionals will share a portfolio strategy and invest your funds across different assets accordingly.

However, if you’re working with a robo-advisor, you’ll simply have to address a few questions around your financial goals and risk profile; the robo advisor will invest your funds in accordance with your risk profile.

Why robo advisors are a good bet?

At DollarGeek, we do thorough reviews of different retirement advisors. Our analysis indicates that lower management fees can help you save hundreds of thousands of dollars over your investment period.

If you add $25,000 to your retirement account that grows at 7% annually,

  • You’ll end up with $163,000 with a 1.5% fees.
  • You’ll end up with $227,000 with a 0.5% fees.

Since robo advisors charge a fraction of what traditional investment management firms do, we recommend investors to try robo advisors and see the difference.

Here is a list of some of the robo advisors with fees as low as 0.25%.

PROVIDER

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Here are some additional benefits of investing with robo advisors:

  • Access to professional money management without minimum investment requirements.
  • You pay a fraction of fees in comparison to traditional investment management.
  • Your money is invested based on proven, sound financial principles.
  • Receive the benefit of tax-loss harvesting.
  • Investments are made in accordance with the rules defined within the algorithm instead of emotions.

Tax mistakes you don’t want to make with a 401(k) rollover

A 401(k) rollover can go incredibly wrong if you miss the 60-day grace period for indirect rollovers. Here are some mistakes you should avoid when doing a 401(k) rollover.

  • Failing to complete a rollover in 60 days.
  • Failing to comply with the one-year waiting rule for 401(k) rollover.
  • Failing to abide by the same property rule for indirect rollovers.
  • Trying to rollover required minimum distributions (RMDs).

Our recommendations

A 401(k) rollover is simple if you follow the IRS-designated rules. The process takes anywhere between two to three weeks for direct rollovers. Be careful when processing an indirect 401(k) rollover. You don’t want to cough-up taxes for silly mistakes!

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