How to Rollover Your Old 401K to an IRA

You can be put into this 401k rollover decision if you leave your job through retirement; a new job; or any other termination of employment.  A rollover is really just a tax-free movement of cash and assets from an old retirement plan to a new retirement plan


The purpose of a rollover is to avoid paying income tax and penalties on the value of your 401k account. A distribution to you of cash or other assets such as stock from your 401k triggers a taxable event. This is because your 401k was made up of previously untaxed items of salary deferrals, employer matching contributions, and yearly market growth.

Direct 401k Rollover to Your IRA

The best way to accomplish a tax-free 401k rollover is to use a Direct Rollover. A Direct Rollover is a direct transfer of assets from your old 401k to your Individual Retirement Account (IRA).  The custodians of both your 401k and IRA do all the necessary paperwork to complete the transfer. In this way, you never possess the 401k assets and therefore would not be subject to income tax and penalties.

You also could make a tax-free direct 401k rollover to your new employer's 401k plan, instead of to your IRA.  Most 401k rollovers though, are transferred to IRAs.

Just starting a small business?  You could set up a 401K retirement plan for your small business and then direct rollover your old 401K into your new Small Business 401K Plan.

What if I just cash-out my old 401k and don't use a direct rollover?

You may elect to receive your old 401k assets without making a direct rollover. This is known as a "cash-out" of your 401k. The big downside of this is that your employer is required to withhold federal income taxes of 20% of your 401k value. In contrast, the IRS does not require any income tax to be withheld on a Direct Rollover.  You could still do a tax-free rollover to an IRA of your 401k cash-out, if completed within 60 days from the 401k distribution date.  However, you would have to add other personal funds to the rollover to make up for the amount of taxes that were withheld --- which could be a sizable amount.

If you don't do any type of a rollover, you will be subject to paying IRS income taxes plus a 10% early withdrawal penalty, if you are younger than 591/2.  Some people wrongly assume that the 20% income tax withheld is the entire amount that they will owe Uncle Sam --- and that they will not have to pay any more taxes when they file their income tax return.

This is a gigantic mistake that you don't want to make. The total tax bill will depend upon your other income and your tax bracket. The combined federal income taxes and the 10% penalty can easily be 32% and as much as 47% of your 401k account.

So, if your 401 cash-out was $300,000 and the tax and penalty was 47%, you would be paying $141,000 to the IRS. That's a big chunk out of your retirement savings and it is gone forever. Plus, since you only had 20% withheld or $60,000, you will have to pay an additional $81,000 to the IRS when you file your federal tax return.  Depending upon what state you live in, you may have to pay more in state income taxes.

Investing your 401k rollover assets that are now in your IRA

Okay, now you have made the decision to rollover your old 401k plan to an IRA. That was a fairly easy decision. The not so easy decision is --- where do I invest with my 401k rollover retirement money?

There is no correct perfect answer as to how to invest your retirement money. It depends upon many factors such as: your age; how many years before you plan on retiring; your investment experience; your current financial status,etc.

The most important factor though may be your tolerance to investment risk. Don't forget, your 401k rollover is your retirement nest egg and you must exercise some caution --- better yet you must exercise extreme caution.

If you feel uncomfortable investing in stocks and mutual funds, your best choice could be:

  •  Bank Certificates of Deposits (CDs) 

  •  Bank Savings and Money Market Accounts 

  •  U.S. Treasury Bonds, Bills, & Notes.


If CDs, Savings Accounts, and U.S Treasury obligations seem too conservative to you, you have more choices for greater returns. These include:

For more investments and more control of your IRA, a Self-Directed IRA may be a better choice for you.