Is It Time to Rollover Your 401(k)?

August 6, 2020 Author: Tess Downing, MBA, CFP®, Complete View Financial

Complete View Financial

Should you consider a 401(k) rollover? So far in 2020, many people have experienced major career changes. In addition to the challenges you’d already expect in a volatile jobs market—such as high rates of unemployment—some people are also discovering that pursuing a new job or career can also create some retirement complications as well.

To know whether it’s time to either rollover or consolidate your 401(k), you should be sure to understand what, exactly, a 401(k) actually is. A 401(k), as defined by the IRS, “is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.” These plans, which are only offered by some companies, give employees a unique opportunity to defer some of their savings and, due to employer contributions, grow their savings at a remarkably faster pace.

Usually, a person will rollover or consolidate their 401(k)s after they have changed jobs or have entered a new stage in the financial planning process. When rolled over, most 401(k) plans will be turned into an Individual Retirement Account (IRA). These accounts, which can also benefit from employer contributions, are connected to an individual, rather than a specific job (a small, but important difference). Some of the other reasons someone might rollover to an IRA include more flexibility and investment choices, fewer fees and regulations, and the option to pay taxes up front (via a Roth IRA), rather than waiting until you retire.

What is a 401(k) Rollover?

A 401(k) rollover is an event where an individual transfers their wealth from a 401(k) account into a new account type, which, as suggested, is usually an IRA. As of 2020, the IRS imposes a 60-day window in which the 401(k) must be rolled over. Waiting longer than 60 days from when a distribution has been received will create a “taxable event.” With some exceptions, you are also limited to one 401(k) per year.

What is a 401(k) Consolidation?

There are many situations in which a given individual might have multiple 401(k) accounts, such as working multiple 401(k) offering jobs within a short amount of time and working at a company that has experienced structural changes (such as going public). Withdrawing from these accounts before the age of 59.5 may trigger a 10 percent penalty, which is why it is extremely important to be careful with where you are directing your money. If you do have multiple 401(k) accounts, then you may want to consolidate these accounts into a single IRA. By doing so, you will protect yourself from fees, make bookkeeping easier, and also give yourself an increased level of flexibility.

How Do I Decide Which IRA is Right for Me?

Contrary to what some people assume, there are many ways that IRAs can vary from one another. One of the first things you will need to consider will be your personal level of risk tolerance. While investing in equity will generally yield higher rates of return, there will also likely be some years in which your wealth is diminished. Investing in fixed income (bonds) provides you with a lower rate of return, but these returns are much less volatile, making it easier to plan confidently for the future.

It will also be crucial to state to your financial institution that you want a direct rollover. Failing to clarify the need for a direct rollover could result in 20 percent of this money being held, by law, for taxes.

In some instances, it might make sense to keep a 401(k) with a previous employer open, even if you are no longer working there. However, in many situations, it will make sense to rollover or consolidate these outstanding 401(k)s into a single individual retirement account. When pursuing either consolidation or rollovers, be sure you understand all limitations, taxes, and potential obstacles.