This article walks you through how and when to do a retirement account rollover. Topics include:
- Understanding Rollovers
- What to Roll Into What
- 4 Steps to Complete Your Rollover
Understanding Rollovers
A rollover is when you transfer funds from one type of financial account to another, like if you transfer your old 401k to another account.
You can do a rollover once you leave your employer. Some employers give you the option to rollover your money while you are still employed, but that’s not the norm.
Employer Retirement Plan Types
All employer retirement plans allow you to save and invest for retirement directly from your paycheck every month. The account type that you have access to just depends on what type of company or entity you work for:
- 401k & Roth 401k – most common type of employer plan, offered by for-profit companies
- 403b | Roth 403b -offered by nonprofits, public schools, and government entities
- 457b | Roth 457b – offered by state and local governments
Roth Designation
Your company may offer your account type with a Roth option as well. Roth means that the money is taxed before it’s contributed to the account. You pay taxes on the money now, and then when you need the money later, it’s tax free.
With the regular account option, like the 401k, the money you put into the account is not taxed up front. So you get a tax break now, but the money gets taxed later when you take it out.
The Roth option is newer, so not all employers offer them. If your employer does offer the Roth option, then you get to decide whether to contribute to the regular account type or the Roth option.
What should you choose?
I always opt for the Roth option if it’s available. I like that I can pay the taxes up front and never have to worry about them again, especially since I hope to be in a higher tax bracket later in life. This also makes it easy to rollover the money into my Roth IRA once I leave my employer (which we’ll discuss in a second), so that gives me all of the awesome Roth IRA benefits.
Deciding whether to contribute to a Roth account vs. a regular retirement account is a personal decision based on your financial situation. In general, if you are younger or on the lower end of your earning potential, then the Roth is the better option. Check out this article by the balance for an in-depth discussion about how to choose the best option for you.
What to Roll Into What:
After you leave your employer you are eligible for a rollover. You have 2 options:
- Rollover the money into an individual retirement account (IRA)
- Rollover the money into your new employer’s retirement plan
I always rollover my money into my Individual Retirement Accounts (IRAs). I recommend this method because IRA accounts offer more investment options, more control, and greater flexibility than employer plans.
There are two Individual retirement account types: IRA and Roth IRA. The difference is in the tax treatment, just like with employer retirement accounts.
With an IRA, you get a tax break up front and then taxes are taken out once you retire, similar to a 401k. With a Roth IRA, you pay taxes on the money when you put it into the account so that you don’t have to pay taxes on it when you retire, just like a Roth 401k.
This visual will help you figure out which retirement account you need for your rollover:
4 Steps To Complete Your Rollover
Now that you understand the strategy, let’s dive into how to actually complete the rollover.
Step 1: Set Up Your Individual Retirement Accounts
You need somewhere for the money to go, so this is where you create your individual retirement accounts. Create both an IRA and a Roth IRA so that no matter what employer plan you have in the future, you can easily rollover the money once you leave. Also, if you set up your Roth IRA right now and contribute to it regularly, you will jump start your journey to financial freedom.
Create your accounts at a brokerage firm
My two favorites companies are Vanguard and Fidelity. Setting up the account is as simple as clicking “create account” and following the instructions. Remember to do this twice – once for your IRA and then again for your Roth IRA.
Vanguard:
- Create Rollover IRA
- Select “Move an account or assets to Vanguard”
- Create Roth IRA
- Select “New Account” and then follow the steps. Select “Retirement Account” and then “Roth IRA”
Fidelity:
*** One note: You may see the option to create a Traditional IRA or a Rollover IRA. Both accounts do the same exact thing and have the same tax treatment. The only difference is that the rollover IRA is designed for people transferring old employer plans, so the brokerage company helps walk you through the steps like I’m doing here. I liked this feature so I created a Rollover IRA.
Step 2: Contact Your Old Employer
This is where you need to contact your old employer and tell them that you want to rollover your old retirement plan directly into your IRA. Just keep in mind which account you want the money sent to – either your IRA or your Roth IRA based on the Rollover Guide above.
Next, you will provide your brokerage firm and account information to your old employer so they can send the funds directly to your new IRA or Roth IRA. Your brokerage firm has all of the details that your old employer needs to complete the transaction.
Step 3: Consider a Roth Conversion
This step is an option if you rollover a 401k, 403b or 457b account into your IRA. That money has not been taxed yet, and it won’t be until you retire, unless you decide to convert it to your Roth IRA. There are benefits to doing this, which I outline in my article Why I rolled over $8,461.02 from my 401k to my Roth IRA.
When you convert your IRA money to your Roth IRA, the amount that you convert gets treated as taxable income in the year that you do the conversion. So here are some points to keep in mind:
- Understand how this conversion impacts your tax bracket. It’s ideal to do your Roth conversion in a year where your taxable income is lower, or in a year where you can afford the additional taxes.
- Once you convert your IRA money to your Roth IRA, this cannot be undone. This used to be possible, and it was called recharacterization, but it’s no longer allowed as per 2017 legislation.
Step 4: Don’t forget to Invest!
Once you complete your rollovers and have your money in your new IRA and/or Roth IRA, don’t forget to invest it! The investing process is what actually grows your money over time. Exactly what you invest in is your choice, but my two favorite options are included below.
- Target Date Funds
- Index Funds
Find out more information about each option in my article I Wanna Roth.
If you have any questions or want to discuss your specific rollover scenario, reach out to me. If the employer plan that you have is different than the accounts I discuss, check out the IRS Rollover Chart to see exactly what you can and cannot do.
Disclaimer: I am not a certified financial advisor and this article is intended for educational purposes only