When you leave a job and have rollover money from your old employer's 401(k) plan, you have a few choices as to what to do with the money. Once you decide that you want to pull it out of the plan, the decision is whether to put it into a new 401(k), put it into an individual retirement account or pay some tax and put it into a Roth IRA. Each choice has benefits and drawbacks. If you're rolling over an existing IRA, you can put it into a different IRA or into a Roth. You can even put it into a 401(k) plan, if your employer allows it.
Rolling your retirement money over into a new 401(k) plan offered by your new employer may be your safest choice. Money in a 401(k) plan is always protected from creditors, from bankruptcy and from the bankruptcy of the company that sponsors it (your employer), while rollovers to IRAs are protected only if they're kept separate. In addition, using your employer's 401(k) may give you access to better funds that have lower costs than the ones you'd use in your IRA. Rolling your funds to a 401(k) lets you start withdrawing penalty-free if you retire at age 55, as well.
Rolling your 401(k) or your previous IRA into an IRA typically gives you more investment choices. 401(k) accounts are usually limited to the investment plans that your employer selects, while IRAs let you buy anything that your custodian will allow. In a traditional IRA, you can usually buy stocks, bonds, mutual funds, annuities and certificates of deposit while self-directed IRAs open your options up even wider to include shares of private companies, precious metals, private loans and real estate. If your employer's 401(k) has high fees, the investments you choose for your IRA could also end up being less expensive to own.
Rollover Roth IRA
Another option is to roll your 401(k) or rollover IRA funds into a Roth IRA. If you do this, you'll have to pay taxes on the transfer, since Roth IRAs are funded with taxed money. However, the money you pull out of your Roth IRA in retirement will be tax-free. Generally, if you anticipate that you will pay higher taxes in retirement than you do now, paying your taxes today makes sense. If you choose to do this, bear in mind that you can't use rollover funds to pay the taxes since, if you do, they'll be considered an early withdrawal and be subject to taxes and penalties.
General Rollover Rules
When you rollover funds from your 401(k) to your new account, try to structure it as a direct trustee-to-trustee rollover. When you do this, the funds go right from one account to the other without your receiving a check. if you get a check, taxes will be withheld from it. Not only will you have to deposit the check within 60 days, but you'll also have to deposit the amount that was withheld out of your own funds. Once you rollover your funds, you'll also have to decide where to invest them. If your asset allocation was optimal in your old plan, you can probably recreate it using the same or similar funds in your new account. However, you may also want to use the rollover as a chance to reallocate your funds. One rule of thumb is to put a percentage of your account into bonds that equals your age. If you're 40, you'd allocate 60 percent to stocks and 40 percent to bonds, but if you're 63, you'd put 37 percent in stocks and 63 percent in bonds, for example.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.