401(k) Rollovers

A 401(k) is an employer-sponsored retirement account with multiple benefits. Account holders contribute pretax dollars, typically through automatic payroll deductions. That equates to a tax savings in the years when you make your contributions. The money then grows on a tax-deferred basis, meaning you won’t pay taxes until you distribute your funds in retirement. But what happens to a 401(k) if you leave your job before you retire?

The good news is that money in your 401(k) can typically continue to grow, tax-deferred. But sometimes in order to avoid fees, you may want to roll over the funds in your 401(k) to a similar account, like a 401(k) at a new employer or an individual retirement account (IRA). Here’s an overview of how it all works.

What is a 401(k) rollover? 

A 401(k) rollover is exactly what it sounds like. It involves taking a 401(k) from a previous employer and “rolling it over” into a new account. Basically, you’re moving the money from one tax-advantaged account to another. That’s key, as the money must stay in a tax-advantaged account, or the IRS will charge you a penalty and any taxes owed.

Why do a 401(k) Rollover? 

It’s usually possible to leave your 401(k) funds where they are, even if you leave an employer. But there are a number of reasons a rollover may still make sense. One of the most common is simplicity. Having all your funds in one place just tends to be easier than having lots of accounts strewn about.

The plan provider might also charge fees for maintaining the account or require you to move the account if the balance is too low.

Finally, a 401(k) rollover can give you more control of your money and could expand your investment options — particularly if you opt for an IRA. IRAs typically offer a broader range of investment choices when compared to a 401(k).

How does a 401(k) rollover work? 

When it comes to getting your funds from point A to point B, you have two options:

• A direct rollover: With this option, you contact your 401(k) provider and request that they transfer the account balance to a new account on your behalf. This might be an IRA or a 401(k) with your new employer. In some cases, the administrator might send you a check made out to the new 401(k) or IRA. You can simply forward it to the appropriate financial institution or administrator. 
• An indirect rollover: Instead of sending the money to a new account, the 401(k) provider disburses the funds to you. It’s then your responsibility to deposit it into a different account. Dragging your feet could cost you: There are usually tax consequences if you don’t deposit the funds within 60 days. (More on this below.) 

Whether you go direct or indirect, there are several different accounts you can roll your funds into.  

1. Rolling your 401(k) into an IRA

A traditional IRA can be a great home for old 401(k) funds. IRAs typically offer more investment options and control than a 401(k).  With an IRA, you could even continue to make regular tax-deferred contributions in the future, reducing your taxable income during your working years. As with a 401(k), you’ll be taxed on distributions.

In 2023, you can contribute up to $6,500 across all your IRA accounts ($7,500 if you’re 50 or older). Money that’s transferred into an IRA or new 401(k) during a rollover does not count toward your annual contribution limit.

2. Rolling your 401(k) over to a new employer’s retirement account 

If you have access to a new 401(k) and rollovers are permitted by your new employer, you might consider rolling your funds into that account. It puts all your 401(k) funds in one place and allows you to build on your savings. 

3. Converting to a Roth IRA 

A Roth IRA is a different type of tax-advantaged retirement account. Unlike a 401(k) or traditional IRA, it’s funded with after-tax dollars.  You can withdraw your contributions whenever you want, tax-free, however, you may have to pay taxes and penalties on earnings.  To tap investment gains without penalty you’ll need to have held the account for at least five years and be 59½ or older. Roth IRAs can be a great way to help manage your taxes in retirement. 

It's possible to roll 401(k) funds into a Roth IRA, but you’ll owe taxes on the rollover amount in the year that you convert. 

Remember, it’s not all or nothing: You could roll portions of your old 401(k) into any of these options. 

How do taxes work with 401(k) rollovers? 

As long as you get your funds into a new 401(k) or IRA within the 60 day time period set by the IRS (or do a direct rollover), there’s no tax implication for rolling over a 401(k). If you do a Roth conversion, you will owe tax on the amount you convert in the year that you convert. And since the distribution counts as taxable income, it could also bump you into a higher tax bracket. Finally, if you take money out of your 401(k), you will likely owe taxes on the amount you distribute (in addition to a 10 percent penalty if you are not 59½ or older). 

Finding the right 401(k) rollover 

A 401(k) rollover allows you to continue to leverage the tax advantages you enjoyed with your old retirement account. You have several options — what matters most is building your nest egg in the most tax-efficient way possible. Some may prefer to put the balance into a new 401(k) with a different employer. Others might like the flexibility and tax benefits of an IRA. Both 401K plans and IRAs typically involve fees, such as investment-related expenses, plan or account fees.  A financial advisor can help you make a decision that works best for your situation. 

This article is not intended as legal or tax advice. Northwestern Mutual and its financial representatives do not give legal or tax advice. Taxpayers should seek advice regarding their particular circumstances from an independent legal, accounting or tax adviser.