401(k) rollover to an IRA: Why and how to do it

Key points

• A 401(k) is a workplace plan that allows employees to save for retirement.
• An IRA is a retirement plan managed by individuals.
• You can roll over your 401(k) funds into an IRA.

A 401(k) plan is an excellent, tax-advantaged way to save for retirement. But you may wonder what happens to that money when you leave your job.

When you leave your job, you have several options for the money in your 401(k), including leaving it where it is, moving it into a different 401(k) plan with your new employer or cashing it out. 

But another popular choice is rolling your 401(k) funds into an individual retirement account (IRA). 

How does a 401(k) work?

A 401(k) is an employer-sponsored retirement plan offered by many for-profit companies in the U.S. Workers can contribute a percentage of their paychecks — up to $23,000 in 2024 or $30,500 for employees age 50 or over — into the plan. Those funds are then invested, often in diversified mutual funds.

There are two basic types of 401(k) plans: traditional and Roth. 

With a traditional 401(k), workers contribute pretax dollars, which grow tax-deferred in the account and are subject to income taxes during retirement. Workers invest after-tax money and enjoy tax-free growth and tax-free distributions with a Roth 401(k).

An employer may also contribute to employees’ accounts, often matching a percentage of an employee’s salary.

“Typically, there is a time requirement set by the company before a worker fully owns the contributions made by the employer, which is known as a vesting schedule,” says Antonio Tovar, a certified financial planner and wealth manager at Stone Wealth Management. “However, contributions made through the employee’s check deferral will always be owned by the employee immediately.”

How does an IRA work?

An IRA is another plan that allows workers to save for retirement. Unlike 401(k) plans, employers don’t offer or manage IRAs. They are individual accounts anyone can open with a brokerage firm.

“IRAs are very common and can be found in virtually most, if not all, financial institutions, such as financial advisory firms, broker-dealers, insurance companies and banks,” says Jason Grantz, a partner at Integrated Pension Services.

Like 401(k) plans, IRAs allow you to make traditional or Roth contributions — up to $7,000 in 2024 or $8,000 if you’re age 50 or older — but there are additional restrictions on these accounts.

While anyone can contribute to a traditional IRA, you may not be eligible to deduct your contributions if you or your spouse has access to a workplace retirement plan and your income exceeds certain limits outlined by the IRS.

How to roll over your 401(k) to an IRA

There are certain times — such as when you leave a job — you can roll the money from your 401(k) into a different account, including an IRA.

“Most commonly, it’s because the individual has terminated service, but it could also be because the plan allows for in-service distributions and the individual has exceeded age 59½ or because of something else, such as death or disability,” Grantz says.

There are two ways to do so.

1. Direct rollover

The simplest way to roll your 401(k) balance into an IRA is by having your 401(k) administrator make a payment directly to your IRA. To initiate a direct rollover, ask your 401(k) administrator for instructions. 

Your 401(k) administrator may issue a check payable to your new account. Your IRA administrator can tell you where to send the check.

2. Indirect rollover

If a direct rollover isn’t an option, you can use an indirect rollover. Your 401(k) administrator will send a check made out to you for the balance of your account, and you will have 60 days to deposit the full amount into your IRA to avoid being subject to income taxes.

In most cases, you’ll roll over a 401(k) to an IRA when you leave a job. Some employers don’t allow you to roll over your funds while you’re with the company.

The timing for rolling over your funds may be flexible when you leave a job. Many employers allow you to leave money in the plan indefinitely after you depart, meaning you won’t have to initiate a rollover right away. 

But that isn’t always the case. Some employers don’t manage accounts for former employees. In that case, you’ll have to move your funds.

Traditional 401(k) to Roth IRA conversion

If you’ve been contributing to a traditional 401(k), you may consider converting the funds to a Roth IRA. This strategy can provide a number of benefits, but it’s important to understand the process and potential implications. 

Perhaps most importantly, you will have to pay taxes on the converted amount since traditional 401(k) contributions are made pretax, while Roth IRA contributions are made post-tax. But future distributions from the Roth IRA will generally be tax-free, provided certain conditions are met. 

The decision to convert should be based on your consideration of your current and future tax rates, your ability to pay the tax due on the conversion with nonretirement funds, and your long-term retirement goals.

Roth 401(K) to Roth IRA conversion

Converting a Roth 401(k) to a Roth IRA can be advantageous for several reasons. 

First, unlike Roth 401(k)s, Roth IRAs are not subject to required minimum distributions during the owner’s lifetime, giving you more control over your retirement savings. Second, Roth IRAs often provide a broader range of investment options than 401(k) plans. 

The conversion process from a Roth 401(k) to a Roth IRA is typically straightforward and tax-free, as both types of accounts are funded with after-tax dollars. But it’s important to ensure that the 401(k) funds are directly rolled over to the Roth IRA to avoid tax implications. 

As always, consider your individual circumstances and long-term financial planning goals when making this decision.

Who should roll over their 401(k) to an IRA

In most cases, you should roll over your 401(k) balance when you leave a job. Two common options are rolling your balance over to a new 401(k) or IRA. By choosing an IRA, you’ll have more control over your investments and your fees.

“Depending on the investment choices they have within their 401(k), it might be possible to save on internal investment expenses and have more direction and control over their options,” Tovar says.

401(k) plans often have limited investment options and expensive fees that cut into your returns. IRAs, on the other hand, offer a wider variety of investment choices. Because you have more investment choices, you have more control over your fees.

But an IRA isn’t right for everyone. The limited menu and administrative services that come with a 401(k) plan might be preferable for people who don’t want to choose their own investments.

“​​People should take into consideration the benefits and drawbacks of rolling over a 401(k) into an IRA,” Tovar says. “The burden of making the investment decisions would then fall onto the individual and with the funds intended for retirement living, the funds require appropriate decision making and care.”

Benefits of rolling over to an IRA

Whether you’re leaving a job and considering rolling over your 401(k) or trying to consolidate several 401(k)s from past employers, there are advantages to rolling over that money to an IRA.

• Tax-neutral. There are several benefits to rolling out to an IRA. Specifically, the rollover can be done in a tax-neutral way, meaning the rollover is sent over as a gross amount and the individual avoids payment of tax until distributions start occurring from the IRA.

• More investment options. Once you’ve moved your 401(k) funds to an IRA, you’ll have a wider variety of investment choices. Many 401(k) plans offer a small list of investments — usually mutual funds — for employees to choose from. But when you move the money to an IRA, you can invest in any of the options the brokerage firm offers.

• Consolidation of accounts. Another benefit to the IRA is to use it as a vehicle to consolidate all the different tax-advantaged accounts that a person has over their lifetime. “Many people work for several companies over their working life, and the IRA can be used to capture each of these amounts in a single place to avoid losing track of or abandoning a prior workplace plan account unintentionally,” Grantz says.

• Reduced fees. Finally, rolling your 401(k) funds into an IRA can help reduce your fees. 401(k) plans often charge fees for plan administration and record keeping in addition to investment fees. According to the National Association of Plan Advisors, 401(k) fees range from less than 1% to more than 2%, depending on the plan size.

And it’s not just 401(k) plans you can roll into an IRA. You can also roll over 403(b) funds, allowing you to consolidate that money with any 401(k) plans you have.

You may be able to find an IRA with lower overall costs than your 401(k) if you shop around. Because you can choose your investments, fees are more within your control.

Similarly, you may not be allowed to contribute to a Roth IRA if your income exceeds IRS limits.

Once money has been contributed to an IRA, it can be invested in nearly anything. Brokerage firms may offer larger selections of investments in IRAs than you find in many 401(k) plans.

Frequently asked questions (FAQs)

What are the tax consequences of rolling a 401(k) into an IRA?

If you roll over your traditional 401(k) contributions to a traditional IRA, there won’t be tax consequences. But if you roll traditional contributions into a Roth IRA, you’ll have to pay income taxes on the amount you roll over.

Can I roll over my 401(k) to an IRA without leaving my job?

In most cases, you can roll over your 401(k) funds to an IRA only when you leave a job or the employer discontinues the plan. But some employer plans allow for 401(k) rollovers while you work there.

Is it better to roll over my 401(k) to a new employer or to an IRA?

Whether it’s better to roll your 401(k) into a new 401(k) or an IRA depends on the investment options available and the plan’s fees.