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Rollover IRA

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Your 401(k) investment may represent years of salary deferrals and hard-earned savings and be a sizable part of your financial support during retirement. If you change jobs or retire, you may be eligible to roll over your 401(k) investments to an individual retirement account (IRA)—known as a rollover IRA. An IRA can be a great way to get more flexibility in managing your investments. While IRAs are a different type of retirement account than a 401(k), they offer many of the same tax advantages.

Advantages of rolling a 401(k) over to an IRA

  • Investments retain their tax-advantaged status. Generally, traditional 401(k) accounts roll into traditional IRAs and Roth 401(k) accounts roll into Roth IRAs.
  • You have access to a broader variety of investment choices than in your 401(k).
  • You may be able to consolidate these investments with other financial accounts.
  • Certain circumstances allow penalty-free IRA distributions before age 59½.

Things to consider

  • Transaction and account maintenance fees may apply in an IRA.
  • Withdrawals prior to age 59½ are subject to a 10% early-withdrawal penalty and ordinary income taxes unless an exception applies.
  • Unlike 401(k) plans, investments in an IRA may not have creditor protection.

Rolling over assets to an IRA is just one of several choices investors have in determining what to do with their old retirement plans. The four options are:

  • Leave assets in a former employer’s plan, if the plan allows
  • Move assets to a new employer’s plan, if the plan allows
  • Cash out/take a lump-sum distribution (taxes and penalties may apply)
  • Roll over to an IRA

When considering rolling over assets from an employer plan to an IRA, factors that should be considered and compared between the employer plan and the IRA include fees and expenses, services offered, investment options, when penalty-free withdrawals are available, treatment of employer stock, when required minimum distributions begin, and protection of assets from creditors and bankruptcy. Investing and maintaining assets in an IRA may involve higher costs than those associated with employer-sponsored retirement plans. You should consult with the plan administrator and a professional tax advisor before making any decisions regarding your retirement assets.

 

The option of cashing out—meaning withdrawing your money rather than rolling it into a new plan or account—may sound attractive, but carefully consider the financial consequences before making such a decision. Not only should you be keeping this money for retirement, your withdrawal will be subject to taxes and penalties.

The downside to cashing out a 401(k):

  • The IRS requires a 20% mandatory withholding.
  • You may be subjected to state and local tax withholdings.
  • Withdrawals prior to age 59½ may be subject to an IRS 10% early-withdrawal penalty and will be taxed as ordinary income.
  • If you fully cash out and then decide to set some of the money aside for retirement, it no longer has its tax-advantaged growth potential.
  • Cashing out may cause you to delay your retirement or reduce your standard of living once in retirement.

Taking the cash early can be costly

Here is an example of what may be left of a $20,000 balance if you withdraw your money as cash:

401(k) balance $20,000
10% IRS early-withdrawal penalty* -$2,000
Regular federal income tax -$5,000
State and local income taxes -$1,000
Cash-out amount $12,000

*May be assessed if you are under age 59½. For illustrative purposes only. Assumes a 25% federal tax bracket and 5% state and local tax rate. Taxes may vary. Depending on your tax bracket, the taxes owed at the end of the year may be higher or lower.

 
 

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Any tax or legal information on this website is merely a summary of our understanding and interpretations of some of the current income tax regulations and is not exhaustive. Investors should consult their tax advisor or legal counsel for advice and information concerning their particular situation. Wells Fargo Funds Management, LLC; Wells Fargo Funds Distributor, LLC; or any of their representatives may not give legal or tax advice.

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