A rollover IRA is a type of retirement account that you can use to hold money transferred from other employer retirement accounts, such as 401(k) accounts or profit-sharing plans. “Rolling” your retirement savings into a separate IRA allows you to retain the tax benefits or your plan, and gives you access to more investment options.
Typically, when you leave a job where you participated in the 401(k) retirement account, you will have a few options to choose from:
Cash out of the plan:While you have the ability to completely liquidate your employer-sponsored retirement account, this option has the most drawbacks. Cashing out puts you in danger of losing the savings you have accumulated, and will likely be subject to federal, state and local income taxes, as well as a 10% fee if you are younger than age 59 1/2. To keep the benefits of tax-deferred investment growth, you have to keep the money in a tax-deferred account, such as another 401(k) or an IRA. However, if you have saved less than $1000 to $5000 in your employer-sponsored plan, you may have no other option but to cash out. This should be discussed with your former employer's human resources department.
Keep the money where it is:Some employers will allow your money to remain in their 401(k) plan after you move on. Unless there is some reason for staying invested in a plan—for example you have access to funds you would not be able to access elsewhere—there is no real benefit to this. The average worker today changes jobs eight to 12 times during a career. If you leave a 401(k) behind each time you leave, you will eventually have a trail of plans. These can be hard to keep track of, and you will likely wind up with a lot of investment overlap. Most importantly, each investment account incurs regular fees. Lessen the number of accounts you hold, and you will boost your returns by saving money that would have been lost to fees.
Bring the money with you:If your new employer allows it, you can move the assets from your former employer's 401(k) to your new employer's plan. This can be a good option for those individuals who don't have a lot of retirement accounts to consolidate. If you are moving your first 401(k), it makes sense to keep those assets consolidated in your new plan, especially if you like the investment options your new employer offers. If you have other retirement accounts that need consolidating, it makes more sense to open a rollover IRA.
Move the money to a rollover IRA:A rollover IRA is simply an IRA that you can move other retirement accounts into. Once you open one rollover IRA, you can use it for all of your 401(k) plans. One benefit to this is access to a wide variety of investments—including stocks, mutual funds, exchange traded funds (ETF), bonds and more—compared to the handful of investments offered in a typical 401(k) plan. With all of your funds in one consolidated account, you can easily track and rebalance your investments as necessary.
Of all of these choices, a rollover IRA makes a lot of sense. Each time you move from one job to the next, you can roll your latest 401(k) plan into your rollover IRA and the investments that you choose. In a rollover IRA, your money continues to accumulate tax deferred, meaning earnings on the money are not taxed until you withdraw the money. If you withdraw when you are in retirement, you will likely be in a lower tax bracket and pay less tax. More importantly, investments that grow without the tax bite compound more quickly. You may also be eligible for a tax deduction on a portion of your contributions to the IRA.
Opening a rollover IRA is easy. If you have an existing IRA, you may want to open a new account with the same financial firm. (You can't use a regular IRA for rollovers.) You can also look into the investment options offered by your bank. Otherwise, look for a low-fee fund company like Fidelity, Vanguard or T. Rowe Price, three of the largest mutual fund companies. An account from an online bank such as ING Direct can be a low-cost option as well. Shop around to find the right account for you.
When you move the funds is important. You have 60 days to rollover funds to another IRA after you withdraw them from the 401(k) plan. If you wait longer than that, the IRS will consider it a distribution, and you will likely be subject to taxes and fees.
Open a rollover IRA and you may be inspired to track down old accounts. Happy consolidating!