How to Roll Over a 401(k) to a New Employer

If you’ve decided to leave your current job for another, you will need to decide what to do with the money that you have invested in your current company’s 401(k) plan. Options typically include leaving it where it is, rolling it over to a new employer’s plan, or opting for an IRA rollover.

If you are about to change jobs, here’s what you need to know about rolling over your funds into a new employer’s 401(k) plan and the ins and outs of other options.

Compare Company Plans

Even if guidance with your 401(k) plan was provided by your company while you were employed, you may find information about rollovers strangely lacking. In most cases, the good news is that the time to make the decision of rolling over your funds is flexible. You can take action as soon as you leave, or you can delay it.

In fact, the latter might be best. “It is best to wait, investigate, then decide to transfer,” said Elliot G. Ford, investment advisor with Ark Financial in Arlington, Wash., who serves organizations nationwide as a broker and retirement plan consultant. “Usually someone in the new company can help you understand the investments, the expenses, and the plan terms at the new company.”

Ford suggests comparing the plan’s history of investment returns and expenses. “Expenses are particularly important. Numerous studies have shown that, other than the amount you contribute, the single biggest predictor of the size of your eventual investment nest egg will be the investment’s expense ratios.” Expense ratio is the total percentage of assets under management that pays for administrative, management, some advertising, and other operating expenses of a fund. “The effect on a fund’s net return can be significant,” Ford said.

Finding someone in your new company to help you compare your old plan with your new one shouldn’t be hard. Most have dedicated personnel providing information and are willing to answer questions regarding the 401(k) plan, or there’s a handy help line to the plan administrator. They want your money, after all.

Move Money to New Employer’s 401(k)

Although there’s no penalty for keeping your plan with your old employer, you do lose some perks. Money left in the former company’s plan cannot be used as the basis for loans. More importantly, investors may easily lose track of investments left in previous plans. “I have counseled employees who have two, three, or even four 401(k) accounts accumulated at jobs going back 20 years or longer,” Ford said. “These folks have little or no idea how well their investments are doing.”

If you have at least $5,000 in your account, most companies allow you to roll it over. But accounts of less than $5,000 can be rolled out of the plan by the company if a former employee does not respond to a notification letter within 30 days.

For amounts under $1,000, federal regulations now allow companies to send you a check, triggering federal taxes and state taxes if applicable, and a 10% early withdrawal penalty if you are under age 59½. In either scenario, taxes and a potential penalty can be avoided if you roll over the funds into another retirement plan within 60 days.

How 401(k) Rollovers Work

If you decide to roll over an old account, contact the 401(k) administrator at your new company for a new account address, such as “ABC 401(k) Plan FBO (for the benefit of) Your Name,” provide this to your old employer, and the money will be transferred directly from your old plan to the new or sent by check to you (made out to the new account address), which you will give to your new company’s 401(k) administrator. This is called a direct rollover. It’s simple and transfers the entire balance without taxes or penalty. Another, even simpler option is to perform a direct trustee-to-trustee transfer. The majority of the process is completed electronically between plan administrators, taking much of the burden off of your shoulders.

A somewhat riskier method, Ford says, is the indirect or 60-day rollover in which you request from your old employer that a check be sent to you made out to your name. This manual method has the drawback of a mandatory tax withholding—the company assumes you are cashing out the account and is required to withhold 20% of the funds for federal taxes. This means that a $100,000 401(k) nest egg becomes a check for just $80,000 even if your clear intent is to move the money into another plan.

You then have 60 days to deposit the remainder (or make up the difference) in your new company’s 401(k) plan to avoid taxes on the entire amount, and possibly a 10% early withdrawal penalty. Even so, that withheld $20,000 has to be reported on your tax return and could push you into a higher tax bracket. All 401(k) distributions must be reported on the recipient’s tax return, anyway. The old plan administrator should issue you a Form 1099-R.

For example, you request a full distribution from your 401(k), which has a balance of $55,000. Using a direct rollover, $55,000 transfers from your plan at your old job to the one at your new job. If the payment is made to you in the indirect rollover, $11,000 is withheld for federal taxes, and you receive a check for $44,000. For this distribution to be completely tax deferred, you must deposit the $44,000 from the 401(k) and $11,000 from another source into a qualifying plan within 60 days.

Rollover Exceptions

There are a few exceptions where parts of the 401(k) may not be eligible for rollovers. These include:

Roll Over 401(k) Into an IRA

For those who would prefer not to rely on their new company’s 401(k) plan’s investment offerings, rolling over a 401(k) to an IRA is another option. Again, rollovers can be direct, direct trustee-to-trustee transfers, or indirect, with the distribution paid to the account owner. But either way, once you start the process, it has to happen within 60 days.

Ford generally favors rolling the money over into the new company’s 401(k) plan, though: “For most investors, the 401(k) plan is simpler because the plan is already set up for you; safer because the federal government monitors 401(k) plans carefully; less expensive, because costs are spread over many plan participants; and provides better returns, because plan investments are typically reviewed for their performance by an investment advisor and a company 401(k) investment committee.”

The Bottom Line

Before deciding what to do with your old 401(k), understand the options available to you first. The biggest pitfall to avoid is triggering taxes and a potential withdrawal penalty by not paying attention to the 60-day rule. The next most common problem is neglecting an old account. By following the above steps, neither will happen to you.