How to Roll Over a 401(k) to an IRA Without Paying Tax: A Step-by-Step Guide

Your four options

When you leave an employer, your 401(k) is still yours. You can:

One note: if your balance is small, your old employer may not let you leave it. Balances under $1,000 can be cashed out automatically, and balances up to $7,000 can be moved into an IRA chosen by the plan.

Why people choose an IRA

• More investment choice. Thousands of funds and ETFs instead of a dozen.
• Often lower fees.
• One place to consolidate old accounts from several jobs.
• You control it, regardless of what any employer does.

Step 1: Open the right kind of IRA

Match the tax type:

• Pre-tax 401(k) money → traditional (rollover) IRA
• Roth 401(k) money → Roth IRA

If you have both in your 401(k), you'll need both kinds of IRA. Not sure of the difference? See Roth IRA vs traditional IRA.

Opening an IRA takes about 15 minutes at a major brokerage. Tell them it's for a rollover. Many will walk you through the rest. Our guides for Fidelity, Schwab and Vanguard show the process.

Step 2: Request a direct rollover

Call your old 401(k) provider or log in to its website. Ask for a direct rollover to your new IRA.

You'll give them:

• The name of the new provider
• Your new IRA account number
• Where to send it (the new provider will give you exact instructions)

The money moves one of two ways:

1. Electronically, straight to the new provider.
2. By cheque made payable to the new provider "FBO" (for the benefit of) you. Sometimes they mail this cheque to you to forward. That's fine. Because it isn't payable to you, it still counts as a direct rollover.

Step 3: Confirm it arrived

Check your new account after a week or two. Make sure the amount matches and that it's coded as a rollover, not a new contribution.

Step 4: Invest it

This is the step people forget. Rollover money usually lands as cash. It will sit there, uninvested, until you choose funds. Don't let it sit for months.

The trap: the indirect rollover

If the cheque is made out to you personally, it's an indirect rollover, and two rules kick in:

20% withholding. The plan must hold back 20% for federal tax.

The 60-day clock. You have 60 days to deposit the money in an IRA.

Here's how it goes wrong. Say you have $50,000.

• The plan sends you $40,000 and sends $10,000 to the IRS.
• To roll over tax-free, you must deposit the full $50,000 within 60 days. You have to find the missing $10,000 yourself.
• If you only deposit the $40,000, the other $10,000 counts as a withdrawal. You owe income tax on it, plus a 10% penalty if you're under 59½.
• You get the withheld $10,000 back as a credit when you file your taxes, which could be many months later.

A direct rollover avoids all of this. Always ask for it.

Should you convert to Roth?

You're allowed to roll pre-tax 401(k) money into a Roth IRA. That's called a conversion. The whole amount is added to your taxable income for the year.

It can make sense if you're in an unusually low tax bracket this year, for example if you're between jobs. It rarely makes sense if it would push you into a much higher bracket, or if you'd need to use the retirement money itself to pay the tax.

When to leave the money in a 401(k)

A rollover isn't always the right call. Consider staying put, or moving to your new employer's plan, if:

You're leaving your job at 55 or older. Under the "rule of 55," you can withdraw from that employer's 401(k) without the 10% penalty if you leave the job in or after the year you turn 55. An IRA makes you wait until 59½.

You own company stock in the plan. A special tax rule called net unrealized appreciation can let you pay lower capital gains rates on the growth. Rolling the stock into an IRA forfeits that. Talk to a tax professional first.

You're a high earner using a backdoor Roth. Having pre-tax money in a traditional IRA complicates backdoor Roth contributions because of the pro-rata rule.

Your 401(k) has very low-cost institutional funds. Some large plans are cheaper than anything you can buy on your own.

You're worried about creditors. 401(k)s have strong federal protection. IRA protection varies by state.

What about a 401(k) loan?

If you have an outstanding loan when you leave, the unpaid balance is usually treated as a distribution unless you repay it. You generally have until your tax filing deadline for that year to come up with the money and roll it over.

Mistakes to avoid

• Cashing out. A $30,000 cash-out for someone in the 22% bracket under 59½ can lose nearly a third to tax and penalties.
• Mixing up account types. Pre-tax to traditional, Roth to Roth.
• Leaving the money in cash after it arrives.
• Missing the 60-day deadline on an indirect rollover.
• Forgetting old accounts. If you've lost track of one, the Department of Labor runs a Retirement Savings Lost and Found database.

The bottom line

For most people, the cleanest move is a direct rollover into an IRA at a low-cost brokerage, followed by investing it right away. It takes a phone call and a couple of weeks, and it keeps every dollar working for your retirement.

Frequently asked questions