Rolling over or transferring a 401(k) to another 401(k)

When an employee leaves a job due to retirement or termination, the question about what to do with the accumulated balance of an employer-sponsored plan such as a 401(k) quickly follows. A 401(k) plan can be left with the original plan sponsor, rolled over into a traditional or Roth IRA, distributed as a lump sum cash payment or transferred to the new employer's 401(k) plan. Each option for an old 401(k) has advantages and disadvantages, and there is not a single selection that works best for all employees. However, if an employee is considering the option of transferring an old 401(k) plan into a new employer 401(k), certain steps are necessary.

The first step in transferring an old 401(k) to a new employer's qualified retirement plan is to speak with the new plan sponsor, custodian or human resources manager who assists employees with enrolling in the 401(k) plan. Because not every employer-sponsored plan accepts transfers from an outside 401(k), it is imperative for a new employee to ask if the option is available at his new employer. If the plan does not accept 401(k) transfers, the employee needs to select one of the three other options for the 401(k) account balance.

If the new employer plan accepts 401(k) transfers from other companies, there is often a substantial amount of paperwork that must be completed by the employee. The paperwork is provided by the new plan sponsor or human resources contact and requires the name, date of birth, address, Social Security number and other identifying information of the employee wishing to effect a transfer. In addition, the 401(k) transfer form must provide details of the old employer plan, including total amount to be transferred; investment selections held in the account; date contributions started and stopped; and contribution type, such as pretax or Roth. A new plan sponsor may also require an employee to establish new investment instructions for the account being transferred on the form. Once the transfer form is complete, it is returned to the plan sponsor for processing.

After the new and old plan sponsors both approve the transfer, the old plan sponsor distributes the balance of the 401(k) account to the new plan sponsor in the form of a check. After the check is received, the new plan sponsor deposits the check, and investments are purchased according to the employee's new plan selections. A transfer from one 401(k) to another is a tax-free transaction, and no early withdrawal penalties are assessed.

The biggest advantage of transferring an old 401(k) into a plan with a new employer is ease of management. Instead of tracking investment selections, performance or statements for multiple accounts, a transfer creates a single account that can be easily monitored. In addition, 401(k) plans typically carry lower fees on investments and transactions than rollover IRAs managed by professional advisers.

Transferring a 401(k) is not suitable for every employee as a number of disadvantages exist. Employer-sponsored plans are limited to a certain number of investment options that can be utilized by employees. These restrictions do not allow plan participants to invest in the exact way they desire and may lead to poor asset allocation or lack of diversification over time. Additionally, employees who participate in a 401(k) do not have a say in the company or individual who manages the plan. A plan sponsor, along with company owners or executives, has total control over how the plan is established and maintained. The process of transferring a 401(k) to a new plan can also be time-consuming, as the new plan sponsor is tasked with vetting the old plan's qualified status; hire and termination dates, and total balance eligible for the transfer. The transfer of an old 401(k) plan to a new plan is a great choice for some employees, but the benefits need to be weighed against the disadvantages before starting the process.