Do you have a 401(k) from an old job? At any point in your law career you may switch jobs. When you leave, you'll have to decide what to do with that employer's 401(k). This post answers the most common questions around a 401(k) rollover: what is a rollover, how do you roll over to an IRA, can you roll over to a new 401(k), can you leave your 401(k) with your former employer, can you cash out your 401(k), and which type of rollover is right for you.
It's not uncommon for lawyers to switch employers over their careers. While it may be the beginning of something new, you may be leaving some things behind at your old employer — one of those things may be your former employer's 401(k).
The 401(k): Unlike a typical brokerage account, a 401(k)'s investments are tax-deferred. There are generally two types: Traditional (pre-tax), where contributions reduce your taxable income now, and Roth, where contributions are taxed now but withdrawals are tax-free. Read more in our post on choosing between a Roth and Pre-tax 401(k).
What is a 401(k) rollover?
There are two types: a direct rollover, where the former administrator sends a check directly to the new 401(k) or IRA, and a 60-day rollover, where the plan sends you a check for the amount minus 20% withholding, and you must deposit the full original amount within 60 days or face penalties and taxes. Direct rollovers are almost always the better choice.
Rolling over into an IRA
You don't need an employer to open an IRA — these are personal accounts, usually set up through a bank or brokerage. Options include Traditional 401(k) to Traditional IRA, Traditional 401(k) to Roth IRA (taxable in the year of rollover), and Roth 401(k) to Roth IRA. A Roth 401(k) cannot be rolled into a Traditional IRA since Roth money has already been taxed.
Rolling over into a new 401(k)
A new plan does not have to accept rollover contributions — check with the administrator first. Options include Traditional to Traditional, Traditional to Roth (within the same plan, taxable), and Roth to Roth (must be a direct rollover).
Can you keep your 401(k) with a former employer?
Yes, unless the plan administrator informs you they intend to distribute the balance. Some investors leave a 401(k) with a former employer if investment options or fees are better than their current plan. Just don't forget about it — Americans have over $1.35 trillion in forgotten old employer 401(k) plans.
Should you cash out?
Cashing out triggers income tax on the distributed amount, plus a 10% penalty if you're younger than 55. You have 60 days after distribution to roll the cash into a new 401(k) or IRA to avoid these consequences.
Which rollover is right for you?
Consider: what type of account do you currently have (a Roth 401(k) must go to a Roth 401(k) or Roth IRA); will your new 401(k) accept rollovers (if not, an IRA is likely your best option); what investment options does the new plan offer (IRAs generally offer more); can you afford the taxes of a Roth conversion (a large rollover amount can push you into a higher tax bracket for the year); and do you want more control over required distributions in retirement (Roth IRAs are not currently subject to required minimum distributions).
A rollover is a typical financial decision that almost everyone will face in their career. Please consult with a tax professional and/or a financial planner if you have any additional questions. Developing Financial performs a rollover analysis for you as part of the Developing Financial Process.
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