401(k) Rollovers: The Complete Guide

Rolling over your 401(k) to an IRA when you switch jobs can provide you with more investment options, lower investment fees and more control over your money. If these features appeal to you, here’s what to know about making the switch.

Getting started with a 401(k) rollover is easy. Just follow these four steps. 

1. Choose between a Roth and a traditional IRA.

You can roll over your 401(k) to either a Roth or traditional IRA. Both allow your money to grow tax deferred, and both have the same annual contribution limits ($6,000 for 2019, plus an extra $1,000 in catch-up contributions if you’re age 50 or older). The chart below shows the differences between the two types of IRAs.

If you want to roll your 401(k) money into a Roth IRA, you’ll have to do a Roth conversion. Contributions to a 401(k) are untaxed, while Roth IRA contributions are taxed. So you’ll have a tax bill to pay when you switch over.

Rolling your 401(k) money into a traditional IRA does not require a conversion or an income tax payment.

2. Open an IRA account.

If you already have an IRA account, you can skip this step. If not, or if you want to open a different type of IRA or use a different provider or avoid comingling funds, here’s what you need to do.

Choose the provider (brokerage) where you want to open your new Roth or traditional IRA and make sure it accepts 401(k) rollovers (it probably does). Open an account online or by phone. 

If you prefer investments from a certain provider, such as Fidelity, Vanguard or Schwab mutual funds, you might want to open your account with one of those firms to get commission-free trades on those products. If you make lots of trades, look for a brokerage with low commissions. If you want a hands-off approach, open your account with a robo-advisor. (Learn more about how to choose a provider in the next section.)

3. Request a direct rollover from your 401(k) plan administrator.

There’s more than one way to do a rollover, but a direct rollover is by far the simplest and will help you avoid mistakes. Your 401(k) plan administrator will send a check for your account balance directly to your IRA provider, who will deposit the money in your IRA. You won’t have to worry about penalties or unintended tax bills. And you’ll only have to pay ordinary income taxes if you’re doing a Roth conversion.

4. Decide how to invest your money.

Letting your money languish in a money market account means it probably won’t grow as much as you need it to if you want to retire. It may even lose money over time due to inflation. A common option is to invest in a diversified mix of stocks and bonds through a low-cost S&P 500 index fund and a low-cost bond fund. Other people prefer to do more research and choose individual stocks and bonds instead of investing in funds. 

While returns are never guaranteed and investments may lose money, this strategy tends to work over the long run.

You almost can’t go wrong these days when choosing a provider. Pick a well-known company with a good reputation and you’ll have access to a huge variety of investments and rock-bottom fees. It will be up to you to make the most of the situation by choosing the investments that are most likely to perform well. But that’s intimidating to many people, so robo-advisors have stepped in to help.

Best for Hands-On Investors

Opening your rollover account with a traditional brokerage will allow you to choose your own portfolio of diversified, low-cost investments and decide how much of your money to allocate to each. You’ll be responsible for your own portfolio rebalancing, and when you make contributions, you’ll need to allocate those to new or existing investments.

When it comes to choosing a brokerage, you have dozens of options. Some of the most popular and well-liked include Fidelity, Vanguard, Schwab, TD Ameritrade, and E*TRADE, but everyone has different preferences: Some people care more about having an easy-to-use interface, while others may care more about account minimums or fees. (Learn more about your options by reading our online broker reviews.)

Best for Hands-Off Investors

If you don’t have the first clue about how to assemble and manage your own portfolio, that’s fine—you don’t have to know these things and making it happen doesn't have to cost much. Nor do you have to be rich. It used to be that the only way to get around managing your own money was to hire a financial advisor, something that was out of reach for most people because they didn’t have enough investable assets.

However, with the emergence of robo-advisors, such as Betterment, SigFig, WealthSimple, and Wealthfront, almost anyone can attain a low-cost, diversified and professionally managed portfolio. Opening your rollover account with a robo-advisor means an algorithm will manage your portfolio for you after you provide your risk tolerance and your intended retirement age.

You can be a hands-off investor even if you don’t choose a robo-advisor. You could go with a target date fund or a couple of index funds.

Some companies have both hands-on and hands-off options or a hybrid option. Check out Vanguard, Schwab, Motif, and E*Trade, for example.

Pay Attention to Fees

Fees affect your returns. The lower your fees, the better your returns, all else being equal. Higher fees are not correlated with better service or better performance.

Keep the long view in mind when evaluating fees. Paying a commission to buy a stock that you hold long term can actually be cheaper than paying a mutual fund’s expenses every year.

Some providers will pay you a bonus for opening your rollover IRA with them. A bonus should not be your sole reason for choosing a provider, but it is a nice perk and it can help offset fees. Keep in mind, the bonus may be taxable income.

You don’t have to roll over your 401(k) to an IRA when you change jobs. You can cash out your balance, but we don’t recommend it because you’ll pay taxes and penalties and lose the progress you’ve made toward retirement. You can also roll over the money to an eligible retirement plan offered by your new employer, such as another 401(k). Some employers may even allow you to leave your 401(k) as is.

Many people who change jobs do choose to roll their 401(k) into a traditional or Roth IRA because of the potential for lower investment fees, more investment options and more control over their money. If you go this route, you’ll need to make some key decisions up front about what kind of account to open, how hands-on you want to be, and which brokerage will handle your account.

With thorough up-front research, you may be able to spend as little as an hour per year managing your account once you’ve completed your rollover. But it’s nice to know you can always revise your choices later—switching brokerage firms or change investments, for example. The most important step now is to complete the rollover correctly to avoid unnecessary taxes.