By in Advanced Investing, Asset Allocation, Investing, Reader Question, Retirement, Saving | 11 comments

How and When to Rollover Your 401K into an IRA

I just switched jobs and have over $100,000 saved in my workplace retirement account. I would like to take the money out and use it for my bills, home repairs, and holiday shopping, what do you think? My new job pays well and so I’m not too worried.” Isabela, age 40

What is a 401K? 

During Isabela’s years of employment, she contributed part of her earnings into a 401K. Employers offer  a program which allows employees to transfer part of their salary into a retirement plan where the funds grow tax deferred. Employers frequently add matching funds into these plans as well.

401k information

Do Not Cash Out Your 401K

The funds are deposited pre-tax and grow tax free. It’s a great way to build a nest egg for retirement.

Isabela contributed $377 per month for 10 years and her employer added $200 per month. The money grew at an annual rate of 7%. Isabela only contributed $45,000 and ended up with $100,000 after 10 years.

Cash Out the 401(K)?

Since Isabela is not yet 59 1/2, if she cashes out her 401K she will owe taxes on the entire amount plus a 10 percent penalty. The penalty alone is $10,000. Additionally, she forfeits the opportunity for the funds to continue growing tax deferred. If she leaves the funds in the existing 401K or rolls it directly into a self directed IRA, the $100,000 could grow to $386,000 by age 60 assuming a 7 percent return. That’s without adding another dime!

Isabela, do not cash out your 401K, it is a losing proposition.

Since your new job pays well, use the income from the new job to pay down debt and shop. Do not cash out the 401K. You cannot get back those 10 years of compound returns. Even if you start a new 401K now, it will take another 10 years to get back to $100,000 (given the same scenario), and at that time you’ll be 10 years closer to retirement.

Your best alternative is to either leave the funds in your previous employers plan or roll it into a self-directed IRA where you can invest the funds as you wish.

How to Rollover your 401K  into an IRA

If you rollover your 401K directly into an IRA, you avoid paying a penalty or taxes. You allow your funds to continue to grow tax deferred. And you may be able to add to the funds (if you are eligible). My husband I have rolled over several 401K’s into IRA’s and the process is quite straight forward.

Choose a discount broker and open an IRA account. The instructions are online or you can call the company as well. We have IRA accounts at Charles Schwab, Fidelity, and TD Ameritrade.

Call the 401K contact and ask how to complete a trustee to trustee transfer. At my spouse’s last job, he filled out some paperwork and faxed it back to the company. That paperwork will ask where you want the funds sent so you’ll need the account information for the IRA account.

The entire transfer was completed within less than one week.

What Happens to the Investments in the 401K?

You must ask the 401K representative about the process. In our recent case, all investments were sold before transfer and the cash was deposited into the new IRA. That creates the opportunity for you to reinvest the funds in the new IRA. In general, I recommend a diversified distribution of index funds, in line with your asset allocation. Learn about how to invest in the free ebook, 20 Minute Guide to Investing.

Why to Rollover into an IRA?

There are many reasons to roll over your funds. Frequently the individual IRA at a discount broker has low or no fees, unlike a 401K. You control how your assets are invested in the IRA. Your money continues to grow tax free until withdrawal. An IRA is one of the greatest wealth building tools.

Isabela, if you’re still unsure, seek the advice of a financial professional for help with this decision.

 What have been your experiences rolling over a 401K into an IRA? Have you ever withdrawn the funds from a 401K only to regret the decision later?

image credit; google images_info_osullivancreel


  1. I have rolled over a few 401K plans to IRAs. The key is never touching the money. You request the IRA to transfer the money. To immediately lose 10% is a good incentive to never withdraw or spend your IRA.


    December 17, 2012

  2. Rolling over that 401k is a great idea. It can generally open you up to a greater range of investment options. We rolled mine over earlier in the year and might even convert it to a Roth at some point.

    John S @ Frugal Rules

    December 17, 2012

  3. @Krantc and John- In 2010 we rolled over a 401K to an ira, never touched it, and got a notice from the IRA regarding the transfer. It’s really important to make sure all of the tax forms are prepared correctly even if you don’t touch the monies. We learned our lesson.


    December 17, 2012

  4. I’m a big fan of rolling over a 401K when leaving an employer. As John said you get more investment choices. But also, if you prefer investing in individual stocks or bonds an IRA can allow you to do that as well.


    December 17, 2012

  5. @Justin, There’s so much more flexibility in one’s own IRA, you aren’t limited to the choices selected by the employers plan. Thanks for stopping by.


    December 17, 2012

  6. Much better plan of action than cashing it out. I’m curious if this works with pension plans as well? I don’t think I’ll be in this situation any time soon, but I do sometimes think if I switch professions, what happens to my pension? Any thoughts, Barb?

    Little House

    December 18, 2012

  7. Hi Little, If you’re teaching you may have a 403B. According to the IRS you can roll over a 403B into an IRA as well. Regarding other types of pensions, you’d need to find out what type of plan and then ask the plan rep. about a roll over.


    December 18, 2012

  8. Barb good advice to your reader, as usual. I also concur that the vast majority of the time rolling to an IRA is a better deal than either leaving the money in the old 401(k) plan or rolling to that of a new employer. Like everything else in finance though, each case is different.

    Roger Wohlner

    December 18, 2012

  9. Roll it over to the new company and leave it and let it grow. Its easier to make more money when you already have a decent start and 100k is great. Losing an additional 10% on top of the taxes would be crazy.

    Thomas S. Moore

    December 19, 2012

  10. Hi Roger, Thanks for reminding us that each case is individual. That’s why it’s helpful, if one has questions to seek out professional advice.
    @Thomas, Agreed, $100,000 is a wonderful base. That’s another reason to avoid pulling the money out of the account. The tax, fees, and loss of the opportunity to grow that sum makes for 3 important reasons to roll the 401K over.


    December 19, 2012

  11. @Ornella, That is exactly what my spouse and I just did. We rolled over his 401K from a former employer into an IRA we set up decades ago!


    December 19, 2012


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