7 Things to Know Before Rolling Over Your 401(k)

What to Know Before Rolling Over Your 401(k)

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Rolling over your 401(k) can be a smart financial move when you're changing jobs or retiring. However, this decision is irreversible once complete, so it’s crucial to understand the potential pitfalls before proceeding. Below are key considerations to help you avoid costly mistakes.

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Understand the Rollover Process

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Most 401(k) rollovers are done by calling your plan’s administrator, although some providers may offer an online option. Regardless of the method, you’ll need three important details:

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1. Payee Information – The check should be payable to the receiving institution, not to your name. If it's payable to you, it will be treated as a taxable distribution, with 20% withheld for taxes.
2. Account Number – This is the number for the IRA or employer-sponsored plan receiving the funds.
3. Mailing Address – Since most rollovers are still processed via paper check, ensuring this is correct is critical.
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Before initiating your rollover, confirm these details with the receiving institution to avoid delays or errors.

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Know the Types of Money in Your 401(k)

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Your 401(k) could include different types of contributions, each requiring special handling during the rollover process.
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• Pre-tax (Traditional) Contributions – Contributions made before taxes, with taxes owed when withdrawn in retirement.
• Roth Contributions – After-tax contributions that grow tax-free, provided certain conditions are met.
• After-tax Contributions – Similar to Roth contributions, but any earnings on this portion are taxable when withdrawn.
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If your 401(k) includes after-tax contributions, those funds can often be rolled directly into a Roth IRA, while the earnings portion typically goes into a Traditional IRA.
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Even if you contributed exclusively to your Roth 401(k), company matching contributions are placed in the pre-tax account.

Address Any Outstanding 401(k) Loans
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If you have an outstanding loan on your 401(k), it’s critical to understand the repayment rules.
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• In most cases, when you leave your employer, the loan must be repaid in full within 90 days.
• If not repaid, the unpaid balance is treated as a taxable distribution and may incur a 10% early withdrawal penalty if you're under 59½.
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Some plans allow you to continue repaying the loan after separation, but you’ll typically need to send payments manually via cashier’s check, money order, or linked bank account. If you plan to continue paying, you'll need to leave your 401(k) in place until the loan is fully repaid.
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Have an Investment Plan for Your Rollover Funds
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When you roll over your 401(k) into an IRA or a new employer plan, those funds typically arrive as cash. Unless you're working with an advisor or using an automated platform, this money won't be invested automatically.
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Creating an investment plan before your rollover ensures your funds are reinvested quickly, minimizing time out of the market and potential missed growth opportunities.

Watch Out for the Pro-Rata Rule
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If you’re using a backdoor Roth IRA strategy, rolling pre-tax money into a Traditional IRA can complicate your tax situation. The pro-rata rule requires that your Roth conversion be treated proportionally between your pre-tax and after-tax IRA balances.
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In this case, it may be better to:
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• Leave your pre-tax money in your 401(k), where the pro-rata rule does not apply.
• Alternatively, roll your pre-tax balance into a new employer’s 401(k) to keep your IRA clean for backdoor Roth contributions.
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Consider Net Unrealized Appreciation (NUA)
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If your 401(k) holds company stock that has significantly increased in value, you may qualify for favorable tax treatment through Net Unrealized Appreciation (NUA).

This strategy allows you to transfer your company stock to a brokerage account instead of an IRA. By doing so, the original cost basis is taxed as ordinary income, while the appreciated value is taxed at long-term capital gains rates, which are often lower.
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NUA can provide significant tax savings but requires careful planning, so consider working with a tax advisor if this applies to you.

Understand the Rule of 55
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If you plan to retire between ages 55 and 59½, the Rule of 55 may allow you to access your 401(k) funds without a 10% early withdrawal penalty.
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To qualify:

• You must separate from your employer in the year you turn 55 or older.
• Withdrawals must come directly from the 401(k) — not from an IRA.
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If you’re retiring early and may need access to these funds, leaving your 401(k) in place could help you avoid penalties.
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Final Thoughts
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Rolling over your 401(k) can streamline your retirement savings, but mistakes can be costly. By understanding the rollover process, knowing your account types, and having an investment plan in place, you can ensure a smooth transition.

If you found this information helpful, consider subscribing to my YouTube channel where I share retirement planning insights to help you retire with confidence and clarity.

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