When you leave your employer—whether you’re moving to a new job, retiring, or you’re just exiting—you can do several things with your 401(k) account. Two popular options involve rollovers—roll the money to your next employer’s retirement plan or roll the money to an individual retirement account.
And yet, despite their prevalence, there are a lot of misconceptions floating around about rollovers. Here are ten common rollover fallacies:
You have to cash out your 401(k) when you leave a job. Not true. You can absolutely roll over your account when you leave a job, even if you quit or are fired. Cashing out leads to a hefty penalty plus requirements to pay ordinary income taxes on your account balance, and could potentially boost you to a higher tax bracket. Your former employer cannot force you to incur those negative consequences.
You have to leave your money behind in your former employer’s plan. It’s an option to leave your savings in your old employer’s plan, but just as you can’t be forced to cash out your 401(k), your former employer cannot compel you to leave your money in their plan either.
Rollovers are expensive. Not at all. You really shouldn't incur additional costs by rolling money from your 401(k) plan account into an IRA or a new 401(k) plan account. While the financial adviser who helps you manage an IRA may be paid by way of an annual fee, it’s not that different from having to pay retirement plan fees as a 401(k) participant. You may have access to a larger pool of available funds with an IRA, but typically there isn't an upfront expense unless you choose to invest in a mutual fund share with a front-end load.
You can only roll 401(k) money into a new 401(k). Again, no. In addition to an IRA, if your employer offers it, you can roll 401(k) money into 403(b), 457 or Federal Thrift Savings Plans as well.
You have to use a financial adviser who is associated with your 401(k) plan to help you roll your money to an IRA. An adviser who manages your employer’s plan may or may not offer individual retirement planning and even if he or she does, you do not have any obligation to work with that individual. You can work with your existing financial adviser or an entirely new adviser as you roll over your money.
You can’t roll money unless you have an existing IRA with money already in it. No, rollover IRA accounts are created specifically to house money you’re rolling from another retirement account.
Because IRAs have contribution limits and income limits, you can’t roll money into an IRA if you make too much money or you've already contributed to a retirement plan this year. Again, not true. While IRAs do have income limits and annual contribution limits, rolling money into an IRA does not influence or trigger any limitations. The rollover also doesn't affect your ability to make any contributions you would otherwise have been able to make to an IRA in a given year.
You can only roll traditional contributions—you can’t roll money from a Roth IRA or Roth 401(K). Both traditional (pre-tax) and Roth dollars can be rolled. Traditional contributions and earnings originating from traditional contributions will remain classified as traditional after a rollover. Likewise, any Roth contributions and earnings originating from Roth contributions will remain classified as Roth even after a rollover.
You have to roll money into the exact same funds (which is a huge hassle and not worth it). No, so invest away. When you roll over money, you’re selling all shares from your old account and moving cash into a new account within which you’ll buy new shares. There is no obligation to transfer the money into the same funds as your old account.
You can’t roll company contributions, so you have to leave that money behind. If you’re fully vested in your account, the money your employer contributed is yours no matter what. Any money in which you’re not vested is not yours. So when you separate from employment, all vested funds belong to you regardless of where they came from, and all unvested funds return to your employer.
A rollover may or may not be the best answer for your 401(k) when you leave your job. Either way, you’ll make a better decision if you base it on facts and not on misconceptions.
Scott Holsopple is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.