How does a 401(k) to IRA rollover work?


Quick Answer

Roll over a 401(k) to an IRA by opening an individual retirement account with a participating financial institution, and then direct the employer, usually a former employer, to transfer the funds to the IRA. A rollover often occurs when an individual leaves an employer, according to Pinyo Bhulipongsanon for Moolanomy Personal Finance.

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Full Answer

To avoid a potential taxable event, the employer should use a trustee-to-trustee or direct transfer when rolling over the 401(k) to an IRA. To do this, the employer must make the check payable to the chosen investment company. If the check is made out to the individual, there is an automatic 20 percent tax withholding taken from the payment, explains Bhulipongsanon. The individual has 60 days to deposit an additional amount that equals the withheld 20 percent into the IRA before it is considered a cash withdrawal subject to heavy taxes.

With an IRA, compared to a 401(k), investment options are no longer limited to those chosen by the employer. People are able to contribute annually to an IRA up to the set limit, notes Fidelity Investments, which advises people to contribute the maximum allowable amount to their IRAs so they can take advantage of the potential tax-deferred or tax-free growth.

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