Many roll their 401ks into IRAs to consolidate their savings, access a broader range of securities, and gain more control over their investments when they change jobs or retire.
If you decided a rollover is right for you, you may wonder how to get started. Making mistakes along the way could result in penalties and taxes.
This article will walk you through how to perform a 401k rollover into an IRA penalty-free.
1. Select a Brokerage
Brokerages can vary in many ways. Some factors to look for when researching brokerages include the following:
- Investment options
- Research tools
- Customer service
- Online and mobile access
2. Pick a Type of IRA
There are two types of IRAs:
Traditional IRA contributions are tax-deductible, and growth is tax-deferred, but retirement withdrawals are taxed as ordinary income.
In 2023, you can contribute up to $6,500 if you’re under 50 and $7,500 if you’re over 50. If you have a 401k through your new job, your modified adjusted gross income (MAGI) may limit the amount of IRA contributions you can deduct.
You must report this rollover on your tax return, but it isn’t taxable.
Roth IRA contributions are after-tax, but growth and qualifying retirement withdrawals are tax-free.
In 2023, you can contribute up to $6,500 if you’re under 50 and $7,500 if you’re over 50. However, your MAGI and tax-filing status can reduce your contribution limit.
Furthermore, rolling a regular 401k into a Roth IRA can cause tax consequences since you’re moving pre-tax funds into an account that allows tax-free withdrawals.
3. Open Your New IRA
Opening an IRA is usually quick, regardless of the broker. Visit the broker’s website and select your desired IRA type.
You’ll provide basic personal and financial information, like your name, date of birth, contact information, and Social Security number. After that, your broker opens your IRA.
4. Request the Rollover
Your 401k administrator typically sells all your investments in your 401k to perform the rollover.
There are two ways to perform the rollover:
A direct rollover is the simplest option. Your 401k administrator electronically transfers the funds to your IRA broker. You never have to touch the money, avoiding any chances of penalties.
Check with your 401k administrator to ensure direct rollovers are available — some may not offer it.
Your 401k administrator cuts you a check for 80% of the 401k balance. They hold 20% for potential taxes and penalties.
You must deposit 100% of the former balance within 60 days or face penalties and taxes. That means you must come up with the remaining 20% elsewhere.
You get that 20% back as a tax credit for the year you finish the rollover.
5. Invest the Funds
As mentioned, the administrator sells your 401k assets before the rollover. You will have to choose investments in your new IRA on your own or with professional help.
Your broker might have investment management or financial advisory services. Otherwise, you can work with an external financial advisor.
A Note About Company Stock
If you own company stock from your previous employer in your 401k, rolling it over to an IRA may trigger tax consequences. This can get slightly more complex, so it’s best to work with a tax professional to explore your options.
Move Your Retirement Funds Penalty-Free
Rolling a 401k over to an IRA penalty-free is easier than it sounds.
Pick a financial institution and decide which type of IRA you want to open. From there, contact your 401k administrator to request a rollover and try to get a direct rollover if possible.
If direct rollovers aren’t available, deposit your indirect rollover check and the remaining 20% as soon as possible to avoid penalties.
Once the rollover is complete, invest your cash. Work with a financial advisor if you aren’t comfortable doing so yourself.