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

The average worker changes jobs more than 12 times throughout their lifetime, so you’re not alone if you’re considering a switch. However, you may be wondering what to do with your 401(k) when facing such changes.

The good news? You may have several options. Whether you’re seeking flexibility, better investment options or cost savings, learning how to roll over a 401(k) retirement plan to an IRA could be a key piece of your long-term financial strategy.

We’ll walk you through what you need to consider as you decide whether or not to make the switch and how to convert a 401(k) to an IRA if you ultimately decide to.

What are your options for your 401(k) if you change or leave jobs?

If you’re changing jobs or retiring, remember there are decisions to be made regarding your 401(k) if you have one.

In general, you have four choices when it comes to what you can do with your 401(k):

In this article, we’ll explore in more detail the pros and cons of a 401(k)-to-IRA conversion, as well as some of the other options available to you.

What is a 401(k)-to-IRA rollover?

A 401(k)-to-IRA conversion involves distributing the funds from your employer-sponsored 401(k) retirement plan into an IRA. This process is designed to help you  maintain the tax advantages of your 401(k) while unlocking the flexibility and broader investment options offered by an IRA.

Types of assets in 401(k) plans

You may have one or several types of assets in your 401(k) depending on the type of contributions your plan allowed.

Pretax or deductible contributions: These are deducted from your paychecks before taxes. These contributions are tax-deferred, meaning you will not pay taxes until you withdraw the funds.

After-tax contributions: These are deducted from your paychecks after taxes, so these contributions are not subject to additional taxes when you withdraw the funds.

Roth 401(k) contributions: These types of contributions are also deducted from your paychecks after taxes, so they are similarly exempt from additional taxes when you withdraw the funds.

There are generally two types of IRAs you can roll over to:

Traditional IRA: Rolling over your 401(k) into a traditional IRA maintains the tax-deferred status of your funds. Taxes will only apply when you withdraw money. In this way, it functions similarly to a 401(k).

Roth IRA: If you roll your pretax 401(k) assets into a Roth IRA, you’ll pay taxes on the amount you roll over but will enjoy tax-free withdrawals in retirement. All after-tax and Roth 401(k) assets are exempt from any additional taxes when rolling into a Roth IRA.

The choice between a Roth IRA and a traditional IRA largely depends on your current tax situation and long-term financial goals, which we’ll cover in detail below.

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

Rolling over a 401(k) into an IRA can be an effective way to gain control of your retirement savings while taking advantage of more flexible investment options. With an IRA, you’re not limited to an employer-defined portfolio and can explore a greater range of investments.

However, the process requires careful consideration and an understanding of your financial needs.

If you’re switching jobs, before you roll over your retirement assets into an IRA, it is worth considering the suitability and characteristics of your new employer’s 401(k).

If the qualities of your new employer’s plan are better for you – such as lower costs or more desirable investment choices – you may also consider rolling over your 401(k) into the new plan if it’s available to you.

Additionally, you may want to roll over to your new employer’s plan to consolidate your assets into fewer accounts, which may reduce the administrative burden.

With that in mind, there are many cases where rolling over 401(k) funds into an IRA make sense. Here's a detailed step-by-step guide to help you effectively transition your 401(k) funds into an IRA.

Decide between a Roth or traditional IRA

Each account type carries its own tax implications, so it’s important to determine which option aligns best with your retirement strategy.

Opting for a traditional IRA allows for a tax-deferred rollover. This means you won’t pay taxes upfront when transferring your funds. However, you'll owe taxes on withdrawals. For individuals anticipating being in a lower tax bracket in retirement, this may serve as a more advantageous option.

Rolling your 401(k) into a Roth IRA requires you to pay income taxes on the rollover amount when transferring the funds, unless you are rolling over after-tax or Roth 401(k) assets. The benefit here is that, if managed properly, it may allow for future tax-free growth and tax-free distributions in retirement. This option could be ideal if you foresee being in a similar or higher tax bracket during retirement.

While you’re weighing your options, you may want to consult with a financial advisor or tax professional to ensure you make the best choice based on your financial standing and retirement goals.

Choose your IRA provider

Once you’ve identified the type of IRA that best suits you, the next move is selecting a provider.

The market is filled with financial institutions offering IRA accounts, so take your time to conduct thorough research. Having an IRA provider that offers the tools and resources for effective fund management can make a significant difference in building a robust retirement portfolio.

Look for attributes that align with your priorities, such as competitive fees, multiple investment options, a user-friendly platform and reliability backed by a strong reputation.

Initiate a direct rollover

After you’ve opened your IRA account with your preferred provider, the next step is to initiate a direct rollover. This involves requesting your 401(k) plan administrator to transfer your funds directly to the newly established IRA.

Initiating a direct rollover means your funds are sent directly to your IRA, reducing the risk of taxes or an unintentional early withdrawal penalty. This method alleviates unnecessary administrative hassles while keeping you compliant with Internal Revenue Service (IRS) guidelines.

Allocate your funds

Once the rollover process is complete and your funds have been successfully transferred to your IRA, it’s time to determine how you’ll allocate the assets within the account. IRAs typically offer a wider range of investment options than 401(k) plans such as individual stocks, mutual funds, exchange-traded funds (ETFs) and bonds.

When deciding on your allocation strategy, consider your risk tolerance, investment goals and timeline until retirement. Diversifying your portfolio may help mitigate risk while optimizing the potential for long-term growth.

Again, if you’re uncertain, consulting a financial advisor may help, as they can provide recommendations tailored to your individual circumstances.

Monitor and adjust

Post-transfer, you should monitor your IRA's performance and make regular adjustments as needed. This isn’t something you will want to “set and forget.” Instead, take the time to align your IRA allocation with market changes and your shifting financial goals.

By reviewing your investments regularly, you can make sure they’re continuing to meet your expectations and that you’re on track toward achieving a comfortable retirement.

Pros and cons of a 401(k)-to-IRA rollover

Rolling over your 401(k) to an IRA offers several benefits, but it also comes with potential drawbacks that you should evaluate closely before making a decision. The following sections provide an overview of some of the key pros and cons for your consideration.

Pro: Flexibility in investment choices

If you’d rather have the flexibility of managing your assets outside of an employer-sponsored plan, you could roll them into an IRA. An IRA may offer greater flexibility compared to some employer-sponsored plans because you generally won’t be limited to the menu of investments available via a 401(k) plan.

From individual stocks to specific ETFs, IRAs typically allow you to tailor your portfolio to your financial strategy a bit more than most employer-sponsored 401(k) plans that may have a limited number of investment options.

Pro: Ease of account management

Another benefit of a 401(k) rollover to an IRA is that you can consolidate your account with your other retirement accounts, making recordkeeping easier. Having fewer accounts to monitor minimizes the administrative burden and may help you get a more transparent understanding of your retirement savings.

Con: Potentially higher costs

While IRAs provide a wide variety of investment options, they may come with higher costs associated with account management and trading fees in some cases. Weigh these costs against the benefits that come from their flexibility and customization.

Con: Potential creditor risks

401(k) accounts are governed by Employee Retirement Income Security Act (ERISA) regulations, which offer robust protection from creditors in many cases. IRAs don’t necessarily share the same level of protection unless specific state laws come into play.

Con: Tax considerations for Roth IRAs

If you opt to roll over pretax 401(k) assets into a Roth IRA, the upfront taxation on the transferred amount needs to be factored into your broader financial planning. Sudden, large tax bills can impact cash flow or change your income bracket for the year, which can have tax implications.

What to do if you own your employer’s stock in your 401(k)

If you own your employer’s stock that’s grown in value in your 401(k), you may be eligible to take advantage of a strategy called net unrealized appreciation (NUA).

Generally, if you roll your pre-tax 401(k) – including this stock – into a traditional IRA, the transaction is tax-free. When you later take distributions from the IRA, the full amount of each distribution is taxable at your ordinary income tax rate. The NUA strategy, however, allows you to apply potentially lower capital-gains tax rates to the gain in company stock that you own in your 401(k). This strategy is only available when you have a triggering event in your plan such as when you leave your job, upon your death or when you reach the retirement age designated in your plan.

How the NUA strategy works

To execute the NUA strategy, you would make two transfers from your 401(k): You would roll everything in your 401(k) other than company stock into an IRA, and you would take a lump-sum distribution of your company stock out of the retirement account into a taxable account.

A few details to note:

The NUA strategy won’t work in every situation, but it could potentially result in notable tax savings if the circumstances are favorable. You may want to consult with your accountant or another tax professional if you have company stock in your 401(k) plan.

The bottom line

The decision about how to manage your old 401(k) isn’t always straightforward and can have significant implications for your long-term financial health.

Rolling over your 401(k) to an IRA could offer you the benefits of flexibility, broader investment choices and streamlined account management. However, weighing these against potential drawbacks – like higher fees and adjusted tax obligations – is crucial.

Ultimately, the decision should be rooted in your financial goals, tax situation and the benefits that are most aligned with your retirement outlook. Since everyone's situation is different, you should speak to your tax professional before making any decisions. A J.P. Morgan advisor can help put a strategy in place so that you can make the move with confidence.

View Disclosures