If you’re considering making a change to your retirement account—whether it’s because of a job loss, a new job, because you want to try a different investment platform, or some other reason—you may be surprised to learn there are important distinctions between performing a transfer and a rollover with your money.
Both terms are used to describe moving funds from one retirement account to another. But they aren’t interchangeable, particularly when it comes to the tax implications .
What’s the Difference Between a Transfer and a Rollover?
A transfer occurs when an account holder moves funds between two retirement accounts that are the exact same type.
For example, if a person moves an old 401(k) to a new 401(k), a traditional IRA to another traditional IRA, or from an old Roth IRA to a new Roth IRA, that’s a transfer. It’s the most direct way to move funds from one tax-advantaged account to another.
The money is sent from the old plan’s custodian to the new plan’s custodian. The account holder never touches the money, the transaction isn’t reported to the IRS, and there are no limits or restrictions, as long as it’s a change in the provider and not the account type. (Even though they sound the same, a saver can’t move funds from a traditional IRA to a Roth IRA without doing a Roth conversion.
The term rollover is used when an account holder moves money between two different kinds of retirement plans: a 401(k) to a traditional IRA or SEP IRA, for instance, or a traditional IRA to an SEP IRA.
What’s the Difference Between a Direct and Indirect Rollover?
Things can get a bit more complicated with this process—partly because the IRS gets involved (unlike a transfer, a rollover must be reported on your income tax form), but also because there are two different types of rollovers.
With a direct rollover, the funds are sent straight from the old provider to the new one. Much like a transfer, the account holder doesn’t ever see the money. But the original trustee or issuer is required to report this type of change to the IRS. That means account holders will receive a Form 1099-R , even though their money is going right back into another retirement plan, and they’ll have to report the transaction when they file their income taxes.
With an indirect rollover (sometimes called a 60-day rollover), account holders take possession of their funds before moving the money into their new plan. They generally have 60 days to make a deposit into another account and complete the rollover, or the IRS can tax those funds.
And, if the account holder is younger than 59½ and doesn’t move the money to another account by that deadline, they also could face a 10% early withdrawal penalty . (If the account holder keeps a portion of the money and deposits the rest, the penalty and taxes are based on the amount they don’t roll over.)
That 60-day timeline isn’t the only thing that can make an indirect rollover more challenging. Unless the check the account holder receives is made payable to the new retirement account, the original retirement plan administrator is required by the IRS to withhold 20% for taxes. (An IRA distribution is subject to 10% withholding.)
The IRS allows only one indirect rollover each year, no matter how many retirement accounts a saver might have. Just as with a direct rollover, the original trustee will report the transaction and issue a Form 1099-R.
The trustee performing the rollover also will send a Form 5498 with information individuals may use to report a rollover, but that form isn’t filed with the tax return; it’s for informational purposes.
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Is There a Way to Avoid the Early Withdrawal Penalty?
Generally, individuals who are under the age of 59½ must pay a 10% early withdrawal penalty if they keep all or some of the money they pull from a retirement account. But there are certain circumstances when that requirement doesn’t apply.
For 401(k) account holders who lose their jobs, there is an important exception to the IRS early withdrawal penalty. If workers lose their job at age 55 or older, they can take a 401(k) payout without incurring an early withdrawal penalty. This exception helps protect those who are closing in on retirement age if they lose their job and feel they need to use some of their retirement savings to get by.
These account holders still will have to pay income taxes on that money, however. And they’ll no longer have those funds growing for retirement.
So though it may be tempting—with that money right there in their hands—to hold onto all or a portion of the money from an indirect rollover, they might want to get some advice from a financial advisor and/or a tax professional before the 60-day deadline passes.
Why Would Savers Choose to Move to a New Account?
When workers leave a job—whether it’s because they’re retiring, moving on to another employer, or they’ve been laid off or fired—they typically have questions about what to do with an existing retirement account. There are a few options to consider.
• Should they roll over the funds from their workplace 401(k) to an IRA if they’re retiring, or to an IRA or SEP IRA if they’ll be self-employed?
• Should they move their money to a similar retirement account with their new employer?
• Should they leave their savings in the account they have with their former employer if they’re happy with their portfolio choices? (This may not be an alternative for everyone. A new employer may not accept
transfers from an outside 401(k). Or, if the account holds less than $5,000, the old plan’s administrator may close it and send a check in the amount of the proceeds minus the mandatory 20% withholding.)
There are pros and cons to each of these choices—so again, it may help to get some professional advice. And this holds true even if a person isn’t leaving a job: Any time an investor is unhappy with a portfolio’s performance, it may be worth checking out what other providers have to offer.
All retirement accounts are not created equal. Some workplace plans may have limited investment options, and that might keep savers from maximizing growth. Or it could increase risk in a volatile market if they can’t get the diversification they need.
Others plans might not provide much access to someone who can offer guidance specific to an investor’s timeline or goals. A new provider may offer more coaching or have an app that allows investors to more easily track how they’re doing.
Some plans are more expensive because of high administrative and record-keeping costs. Those expenses can slowly eat away at the amount of retirement savings a worker can amass. (And even a small percentage more can make a big difference.)
An investor who has multiple investment accounts might simply decide it’s time to consolidate them into one IRA to make things easier to manage. For example, a worker who changes jobs every few years, and makes a habit of leaving behind 401(k) accounts with all those former employers, may find that over time it’s become difficult to keep track of the investments in all those different plans or even how to access the accounts.
If a new traditional IRA offers similar or better investment choices, lower fees, easier access, and improved communication, it might make sense to roll the old plans into one new account outside the workplace. (Or the worker may choose to maintain a 401(k) with the current employer, as well as an IRA, to take advantage of matching contributions. (Individuals can contribute up to $6,000 each year to an IRA each year, depending on their income , on top of what they put into their 401(k) or other employer-sponsored retirement plan. Or $7,000 if you’re 50 or older.)
On the other hand, workers who have had the same plan for years and are happy with the investment options and services received may choose to leave their money where it is. They just won’t be making contributions to that account anymore.
Questions to Consider When Making a Change
If the idea of doing a rollover to a traditional IRA is appealing, some online comparison shopping can help determine what different providers have to offer. This might include looking at:
• What types of investments will be available (stocks, bonds, mutual funds, exchange traded funds (ETFs), insurance products, etc.)?
• What kinds of fees and commissions are charged?
• Will a professional advisor come up with the investment plan or does the investor have control?
• How do savers access investing information in general, and access their account information specifically?
When deciding on whether to do a transfer or rollover to a new employer’s 401(k) plan, it may help to talk to someone in human resources. Some questions to ask might include:
• Will the new employer accept money from an old 401(k) plan? The new plan is not required to accept contributions from the former plan, so that may not be an option.
• How long must new employees wait before they can begin contributing to their plan? Some companies have a waiting period of six months or even a year.
• What’s the employer’s matching contribution?
• What is the vesting schedule? Even if employees can contribute their own money to the plan right away, they may have to wait a year or longer before they actually own the money the employer contributed to their account.
• What are the new plan’s investment options, fees, etc.?
If things are just too busy or unsettled to make a decision about a transfer or rollover right away, waiting may be the right choice. Most plans allow former employees to leave the money in a 401(k) indefinitely (unless the amount saved is under a required minimum).
But former employees can no longer contribute to an old account, and they can’t take a loan from the account. And if they forget to open a new account elsewhere—or simply choose not to—they could miss out on months or even years of adding more money to their investment savings.
Rollover vs Transfer: Which Makes Sense?
For most people, a transfer may make the most sense when moving money from one retirement account to another. These trustee-to-trustee changeovers make it easier to avoid paying income taxes and an early withdrawal penalty. With an indirect rollover, there’s a greater chance of making a mistake that could result in owing money to the IRS.
And the temptation to spend some of the money they’re holding in their hands may be too much for some to resist—especially if they’ve experienced a job loss or some other personal crisis. However, each individual will have to consider their own needs and goals when they decide how to handle this important decision.
How Can SoFi Help?
If you’re looking for a new provider, feeling indecisive about leaving an old plan, or thinking about rolling over an old workplace plan to a traditional IRA while also maintaining a 401(k) at your new workplace, SoFi Invest is ready to help.
SoFi offers traditional, Roth, and SEP IRAs, and can build a portfolio with a broad range of assets based on an investor’s personal objectives. And it’s easy to get started, because there are no minimums or SoFi management fees.
A traditional IRA can help decrease your tax burden now while you save toward your retirement goals, and it can have an important role in any financial plan.
If you’re ready to make a change to your investment plan—for whatever reason—you can get some guidance from one of SoFi’s professional advisors by scheduling a complimentary appointment at a time that’s convenient for you.
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
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