As we’ve discussed previously, it’s usually a good idea to roll your 401(k) into an IRA after leaving your job. But what exactly do you have to do to rollover a 401(k) account?
In most cases, it’s just 3 easy steps. There are, however, some potential pitfalls along that way that you’ll want to avoid.
Step 1: Open an IRA
If you don’t already have a traditional IRA somewhere, you’ll need to open one. Discount brokerage firms like TradeKing or Scottrade can be great choices here because of their low costs.
Helpful Resource: Here’s a comparison of IRA costs at various discount brokerage firms.
Potential Pitfall: Be wary of brokers in the guise of Financial Advisors. If you use a broker to rollover your 401(k), he’s probably going to suggest that you put it into actively managed funds that charge a commission. This is an unnecessary cost.
Step 2: Request (and Fill Out) Rollover Paperwork
Contact your 401(k) administrator and request the necessary paperwork. Don’t worry–it shouldn’t be too bad. Most likely, you just provide your personal information and the account number for your new IRA.
Tip: You’ll want to initiate a “direct rollover” (sometimes called a “trustee-to-trustee” rollover). That is, do not have the check made out to you. Have it made out to (and sent to) the new brokerage firm. Otherwise 20% of the total balance could end up being withheld for taxes.
Potential Pitfall: If for some reason the check arrives in your own mailbox, don’t panic. Do, however, get it forwarded to the new brokerage firm ASAP. If you don’t get it rolled over into your new IRA within 60 days, the entire amount will count as a taxable distribution.
Step 3: Select Investments
After the cash shows up in your IRA, you have to choose how to invest it. As you know if you read regularly, I strongly recommend index funds and ETFs due to their low costs.
In this particular instance–as well as any other instance in which you’ll be investing a large sum all at once–I’d argue in favor of using ETFs rather than index funds. The one-time commission that you’ll pay will be quickly offset by the lower expense ratios.
One Last Note
Do you have any other 401(k) accounts from prior employers? If you’re taking care of one rollover, you might as well take care of any others at the same time.
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{ 5 comments… read them below or add one }
RE: Step 2 Potential Pitfall. This not only can happen, this may have to happen for some 401k rollovers. I had a 401k with Fidelity and the 401k admin told me i HAD to get the check directly to me (ie. they would not do a direct rollover to the new trustee of the IRA). Thus, it is imperative to follow up, make sure you get the check, and mail it within the 60 days, and confirm it was deposited into the IRA. Then make sure it all got reported properly on your tax return.
Good point regarding “One Last Note” I had two 401k accounts. I got the 1st 401k rolled over with a Fidelity IRA, but when I contacted my previous employer’s ING to roll over the second- I realized that I had to request a name change and change of address form. It didn’t take long before everything was rolled over. I put it in a simple “aggressive growth” (appropriate for my age so I’m told), but I want to do something more with it. I don’t know if the Fidelity agents are what I’m looking for as far as advise. Anyway, these are great tips! By the way, my company, fabeetle, would like to know why you save and invest? tell us your story in 100 words or more and you may win an iPhone. http://www.fabeetle.com/giveaway
Congrats on your book! Can’t wait to read.
In step 1 I would recommend Fidelity over any other firm. They have the lowest cost index funds; even lower than Vanguard. The only downside is those IRA have a 10k min investment.
I’m 69 and retired. I have a 401K with my former employer and it is in a stable value fund. This is the bulk of my retirement savings. I have not withdrawn from it to date. It is not a large amount, but I would like to know what is the best way to transfer it to a IRA, if that is advisable.
Hi Norm.
As to how to do it, you literally just follow the steps above: Open an IRA somewhere, fill out the rollover paperwork, then once the cash shows up in the IRA, invest it how you think is appropriate.
As to whether or not you should do it, this article contains my thoughts. In short: Yes, most people should rollover an old 401k into an IRA. (Here are a few exceptions.)
I generally view it as the best approach to either go to a fund company (Vanguard, for instance) and create a diversified portfolio of low-cost index funds, or go to a discount brokerage firm and create a diversified portfolio of low-cost ETFs. (A few example ETF portfolios can be found here.)