How to Properly Roll Over an IRA or 401(k)

If you have a 401(k) plan or individual retirement account (IRA), it's likely you'll want to roll it over at some point during your working life. In fact, there’s an outstanding chance you’ll need to do this several times.

While there are certain considerations that must be made in order to properly complete a rollover, the process isn't as hard as it sounds. Retirement plan rollovers are actually pretty easy to perform. However, it's important not to blindly charge into retirement rollovers. It's best if you know exactly what you need to do so you'll be able to make the rollover in the most tax-friendly manner possible.

So let's dive into rollovers and how to do them right.

Why Should I Roll Over My 401(k) or IRA?

The most common rollover is from a 401(k) plan to an IRA. And the most common reason for the switch is changing jobs.

When you move to a new employer, you have several options for your existing 401(k). You can leave it where it is, cash it out, move the funds into a 401(k) with your new employer, or roll it over into an IRA (individual retirement account).

First off, let's just say right here that cashing it out isn't a good option. That's because you'll be forced to deal with fees and penalties for withdrawing the funds before you're 59½.

Should I Roll Over My 401(k) to an IRA?

In most cases, the best option is to roll it over into an IRA. You'll have a wider variety of investment options to choose from (including real estate). Plus, opening a Roth IRA can set you up for tax advantages later on down the line.

Here are some more advantages to IRAs:

1. IRAs are completely self-directed, giving you control over all of the investment activity
2. You can choose the plan trustee and change it later on
3. You generally have more flexibility in withdrawing funds from an IRA than you do with an employer plan
4. You can invest in your IRA to make investment fees lower than they would be an employer plan
5. In general, IRAs have fewer restrictions than other types of retirement plans

One of the few rollover restrictions is the one-year waiting period for IRA rollovers. Under IRS rules, if you make a tax-free rollover of the distribution from an IRA, you generally cannot make another rollover from the same IRA within a one-year period. You also cannot make the rollover from the IRA to which the distribution was rolled over.

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Blooom analyzes your 401(k) and makes recommendations regarding fees and performance. It can help you manage the health of your plan so that you're making the most of its investing potential.

Other Permissible Rollovers

Besides the 401(k) to IRA rollover, there are a few others that are possible. Rollovers between retirement plans are generally permitted for most plans. Some common examples include:

• IRA to IRA — Except for the one-year rule above, you can roll over one IRA to another as you see fit.
• IRA to 401(k) — This one takes a lot of people by surprise. You can perform this rollover as long as the new employer 401(k) plan allows it. You are also restricted to rolling over only the tax-deductible portion of your IRA plan. Any amounts not tax-deductible cannot be rolled over into a 401(k) plan. Depending upon the terms of the new 401(k) plan, a rollover can be considerably more complicated. You have to check with the new plan trustee to determine specifically what those terms will be and what you’ll need to do.
• 401(k) to another 401(k) — This is permissible as long as the plan with the new employer allows it. If it does, there may additional rules specific to the new plan.

Whatever type of retirement plan rollover you’re attempting to do, be sure you follow proper procedures which will allow you to do it without suffering any tax consequences and fees — we'll get to those in a minute.

General Rollover Terms

Before getting into the mechanics of rolling over funds from one plan to another, there are a few terms you need to be familiar with:

Direct Rollover — This is where one plan trustee issues the distribution check directly to a new plan trustee. This is the simplest form of transfer and avoids the possibility of triggering income tax liability.

Indirect Rollover — This occurs when the funds are distributed to you, rather than to the new trustee. You're then responsible for moving them to a new account. Indirect rollovers are subject to withholding equal to 10% of the distribution amount from an IRA and 20% from other retirement plans.

60-Day Rollover Requirement — Any retirement funds received by you not rolled over into a new plan within 60 days are considered to be a cash withdrawal and subject to income tax.

IRS 10% Additional Tax on Early Withdrawals — If distributions are considered cash withdrawals and you haven't turned 59½, they'll be subject to a 10% additional tax. There are no exceptions (such as hardship withdrawals).

The Mechanics of a Successful Rollover

No matter what type of retirement plan rollover you’re trying to do, the basic methodology is about the same. Whatever type of rollover you’re trying to perform, be prepared to do the following:

Step 1: Set up your new account before beginning the transfer

If you receive the distribution from your old plan, and then go out looking for a new home for it, you'll risk mistakes that could possibly lead to tax consequences. Find a broker before you close your old account.

Step 2: Contact the current plan administrator

Administrators typically have set procedures for handling rollovers. Let them know you want to do a direct rollover of your old plan into the new one. This will enable you to avoid withholding taxes on the distribution.

Step 3: Make sure the check is made out to the new plan trustee

If the transfer check is made payable to you personally (which is an indirect transfer) the trustee on the old plan will have to withhold income taxes. This will reduce the amount of the rollover and subject you to actual taxes — plus the 10% additional tax on early withdrawals — on the amount of the withholding.

Step 4: Deposit the check within 60 days

Better yet, deposit it immediately so you don’t forget about it. If the funds are not deposited within the 60-day window, it will be considered a regular distribution, subject not only to income taxes, but also the 10% penalty if you're under age 59½.

Step 5: Report the rollover on your income taxes

This is actually a simple affair as long as there is no tax liability on the distribution (and there won’t be if you handle the transfer correctly). Your old plan trustee will issue you an IRS Form 1099-R, reporting the amount of the rollover. It will also indicate it is a non-taxable distribution.

If you're ever in doubt as to how to properly structure your retirement rollover, consult with both the old plan trustee and the new one. The rules for a rollover are very specific, and both trustees will have an established protocol that should make the rollover a stress-free affair.

Need Help With an IRA?

Investment management firm Fisher Investments specializes in helping clients grow their retirement accounts and is a good resource if you're looking for help with your money in an IRA.

Keep Your Investments Going

There are many reasons you may want or need to roll over your 401(k) or IRA. And luckily, it's not as hard as it sounds if you know what you're doing. If you have old 401(k), 403(b), or 457 accounts from past employers, there could be a few reasons to keep things the way they are. Some people may prefer to roll over their old 401(k) into a new 401(k), but that puts you at the mercy of your new plan’s fees and investment options. That might not be the best place for your old money.

Instead, a Rollover IRA gives you freedom and flexibility in your retirement planning. For more information, check out the IRS website for more specific requirements on retirement plan rollovers.