One of the best retirement savings options for many Americans is a 401k. But what happens when you can’t contribute anymore because you left your job? You’re probably wondering, “What’s next? Should I rollover my 401k to an IRA?”
401k rollovers are great options in a lot of cases. There are plenty of benefits. So why do so many of us leave our 401ks just sitting there? Whether it’s paperwork overwhelm or investor paralysis, rollovers can feel intimidating. Let’s explore why 401k rollovers can be so beneficial.
Should I Rollover My 401k to an IRA?
In many cases, rolling over your 401k to an IRA makes a lot of sense. Let's review the benefits of the rollover process, as well as some mistakes you want to avoid when making this money move.
Benefits of Rolling Over a 401k to an IRA
If you’re wondering why so many people choose to roll over their 401k into an IRA, the short answer is: flexibility and control. A rollover can give you more options, simplify your accounts, and potentially save you money in fees. Let’s look at some of the biggest benefits of making this move and how it can help you grow your retirement savings with confidence.
Take Charge of How Your Money Is Invested
There are many perks to 401ks. Honestly, it continues to be one of the most popular retirement options for most Americans. However, one of the biggest drawbacks to a 401k is that you are limited in your options. Most employers give you very little choice over how your 401k is invested. As a result, you might find yourself paying slightly higher fees or making different investment choices than if you created your own portfolio.
The good news is that when you rollover your 401k to an IRA, you regain a lot of that control. Many providers allow you to invest in a variety of stocks and bonds. Additionally, they tend to come with very low fees, especially if you are looking at index funds or ETFs.
What Happens to Your Old 401k When You Leave a Job
Another reason to rollover your 401k is that you can no longer contribute to it when you leave your employer. That might mean starting a new 401k with a different employer. Possibly you’re taking the leap into solopreneurship or maybe you’re on your way to early retirement.
No matter where you end up, though, you cannot contribute to an old 401k. That means your account is just sort of sitting there on cruise control. That’s not ideal! It’s true that your existing investments will still earn compound interest.
However, there’s a very good chance you could find yourself in a position of leaving an employer long before you hit Coast FIRE. That means you need to keep saving for retirement. In fact, if you are in a situation where you can continue to save for retirement, we almost always recommend doing so. As a result, you’ll likely open another account.
Having two accounts might not be the worst thing in the world. However, as more and more Americans practice “job hopping,” you could quickly go from two 401ks to ten!
Make Retirement Saving Easier to Manage
You know you want to keep saving for retirement. You also know that investing can require some work. To streamline your decisions and simplify your finances, you should roll over your 401k into an IRA. My wife and I collectively left 10 jobs where we were eligible for 401ks. Think about how many different accounts we could have had floating out there!
If you’re overwhelmed at the thought of rolling over your account, you can use a tool like PensionBee to help keep things simple! PensionBee helps you combine old 401ks and retirement plans into one easy-to-manage account, so you can see your full retirement picture in one place. Their team handles the transfer process for you, which means less paperwork, fewer headaches, and more time focused on growing your nest egg.
Mistakes to Avoid When You Rollover Your 401k to IRA
Are you mentally shouting “Yes!” to the question “Should I rollover my 401k to an IRA?” In lots of instances, you’re absolutely right. Still, there are some mistakes you will want to avoid.
Always Choose a Direct Rollover
When you’re making a rollover, you want to make sure that you’re actually rolling over your money. That sounds easy enough. However, there have been plenty of instances where people have sent themselves the money via an indirect rollover and then have not completed the rollover correctly.
In an indirect rollover, there is an automatic 20% withholding to cover federal income taxes. Moreso, you have 60 days to move the money before it becomes a taxable withdrawal. In the event that you don’t move the money in a timely fashion, your money is now subject to income tax and possibly even a 10% penalty.
On the other hand, a direct rollover simply moves your money from your 401k to another qualified retirement account. This kind of rollover allows you to bypass the mandatory tax withholding and doesn’t come with any sort of deadline. That’s why direct rollovers are almost always preferred.
Why Cashing Out Can Cost You Thousands
Cashing out your 401k might seem convenient at first. You can probably think of dozens of things to do with all that savings, like paying off debt, buying a car, or even funding a home remodel. But if you withdraw your 401k before age 59½, you’re going to face serious penalties.
Here’s an example: let’s say you have $100,000 in your traditional 401k and decide to cash it out early.
- The IRS immediately takes a 10% early withdrawal penalty, which means $10,000 is gone right away.
- The remaining $90,000 is added to your taxable income for the year. If you’re in the 22% federal tax bracket, that’s another $19,800 in taxes.
- Depending on where you live, state income tax could take another few thousand.
All told, you could easily lose $30,000 or more of your savings to taxes and penalties. That means you’d walk away with closer to $70,000 from that original $100,000.
That’s a steep price to pay for short-term access to long-term savings. Instead of cashing out, consider a 401k rollover to keep your retirement money growing and avoid unnecessary tax hits.
Lean on Experts to Do the Heavy Lifting
If you're going to a new brokerage partner, utilize their services to help you. Reach out to a well-respected brokerage partner that offers low fees. Ask them how to complete a rollover. They can walk you through the process to ensure that you’re doing it correctly.
That means you bypass any penalties and reduce your stress. Plus, they get your business. It’s a win for you and the brokerage!
Learn the Basics Before You Go Solo
Before you start the rollover process, you want to educate yourself on investing. You don’t need to get an MBA in finance, but you do want to understand the basics. How do you get started? Read books, listen to podcasts, and keep it simple.
In fact, some of our most popular Marriage Kids and Money podcast episodes are about investing. Take a listen to see how to get started without a financial advisor. Or tune in to hear how Jeremy Schneider used index funds to become a millionaire!
After you start to get the hang of investing, you can also take a look at your progress. Are you looking to retire early? Or maybe you are pursuing Coast FIRE. Understanding your Coast FIRE number by age or using our Coast FIRE calculator can help you analyze your own progress.
The Bottom Line: Keep Your Money Working for You
You should rollover your 401k if you find yourself in a situation where you can no longer contribute to an existing 401k. Maybe you transfer jobs or try out solopreneurship. Perhaps your employer simply retires that investment option. In those instances, a 401k rollover can be really beneficial.
These rollovers help you keep track of your accounts and require less decision-making over time. To optimize your rollover, find a partner with low fees that will support you throughout the process.
If you feel like a rollover is right for you, consider a service like PensionBee. They make consolidating old 401ks and retirement plans effortless. You can transfer, manage, and monitor your retirement savings all in one place. With portfolios powered by ETFs like SPY and MDY from State Street Investment Management, PensionBee handles the heavy lifting so you can focus on what matters most: building your future and owning your time.
When you’ve completed the rollover process, you’ll feel relief knowing it’s one less item on your investing to-do list — and one big step closer to financial independence.
Have you ever had to rollover a 401k to an IRA? How did the process work for you?
Please let us know in the comments below.
Andy Hill is not a PensionBee Inc. customer and received payments for their endorsement
Your investment can go down as well as up.
This post, and any associated customer testimonial or third party endorsement, is provided solely for informational and educational purposes, should not be taken as tax, legal, financial or investment advice and is not an offer, solicitation, or recommendation to buy or sell any securities or investments.
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