Rollovers
A rollover moves a retirement balance from a former employer's plan into an individual account or into a new employer's plan. A direct transfer between the two institutions avoids withholding and deadlines entirely, while receiving the money yourself introduces both of them.
Leaving a job leaves a retirement balance behind, and it sits there indefinitely if nobody moves it. Moving it is straightforward, worth doing in most cases, and has two consequences that are worth knowing before rather than after.
How it works
The balance moves from the old plan into an individual retirement account or a new employer’s plan. The tax character generally carries over — pre-tax money stays pre-tax, Roth money stays Roth — so nothing is taxed at the point of transfer.
A direct rollover moves institution to institution. You never receive the money, no withholding applies, and there is no deadline to miss.
An indirect rollover pays you and expects you to redeposit it. Tax is generally withheld from the payment, a deadline applies, and you have to replace the withheld portion from other money to roll the full amount.
Indirect rollovers between individual accounts are also rationed. US rules allow one in any 12-month period, counted across all of a person’s individual accounts, and a second is treated as a taxable distribution. Direct trustee-to-trustee transfers do not count toward that limit, which is another reason to choose them whenever an institution offers the option.
A worked example
Take a 60,000 pre-tax balance rolled indirectly with 20% withheld.
You receive 48,000 and 12,000 goes to tax withholding.
To roll the full 60,000 you must deposit 48,000 plus 12,000 of your own money, and reclaim the withheld amount later through your return.
Deposit only the 48,000 and the missing 12,000 is treated as a distribution — taxable, and usually penalized before a certain age. A direct rollover avoids all of this, which is why it is the default recommendation.
Why it is usually worth doing
An old plan’s menu was chosen by an employer you no longer work for. An individual account typically opens the whole market, including the cheapest broad index funds available.
Over thirty years, a 0.75% yearly fee shrinks the ending balance by 20.2% and a 1.5% fee by 36.5%. Moving from an expensive default fund to a cheap index fund is frequently the largest single financial improvement available in an afternoon.
Consolidating also removes the forgotten-account problem, which is the most common way old balances end up in the wrong allocation for a decade.
Two reasons not to
Pre-tax money in an individual account can block a backdoor Roth. Where the pro-rata rule applies, existing pre-tax balances are counted when converting, which can make the strategy unattractive for as long as they sit there. The backdoor Roth page covers the mechanism.
Employer stock inside a plan can have special treatment. In several systems it can be moved out in kind with only part of its value taxed as income, and rolling it into an individual account generally forfeits that permanently.
Both are worth checking before, not after. Rollovers are difficult to reverse.
What to keep
Keep the paperwork showing the tax character of what moved. Pre-tax and Roth balances are treated differently on withdrawal, and after two or three job changes the records are the only thing establishing which is which.
Rules here are statutory, national and revised, so check current figures and deadlines rather than relying on any written down. This is educational, not tax advice.
Costs
Plans often liquidate holdings before transferring. Inside a retirement wrapper that is not a tax event, and it does mean time out of the market between the sale and the repurchase.
Of all ten-trading-day stretches in the S&P 500 since 1950, 59% finished higher, so several days uninvested is not neutral. Asking whether the transfer moves in kind is worth one phone call, and so is asking whether the old plan charges an exit fee or the new provider an account fee; both are listed in their fee schedules.
The original data
Among the 24,971 unique videos in this site’s search study, the nearest account subjects are workplace plans, in 22 videos at a median of 81,626 views, and Roth accounts, in 24 at 95,293.
The question: Three old plans sitting untouched. Consolidate?
The answer is usually yes, and the two checks above come first. If a backdoor Roth might matter, rolling into a new employer’s plan rather than an individual account keeps that door open. If any of the balances holds employer stock, check the treatment before moving it — those two questions take an afternoon and the consolidation is permanent.
When it fails
The failure is an indirect rollover that misses the deadline. The check arrives, life happens, and the window closes on a balance that was never intended to be withdrawn. What was meant as an administrative step becomes a taxable distribution with a penalty attached, on money that had been accumulating for years — and the direct method, which has no deadline at all, was available the whole time.
The second failure is rolling pre-tax money in without checking the backdoor consequence. It is easy to do and hard to undo.
A third is forfeiting employer-stock treatment. It is permanent.
A fourth is leaving old plans behind entirely. Each keeps its own fees and its own stale allocation.
A fifth is not asking whether holdings move in kind. Days out of the market are a real exposure.
And a sixth is losing the records. The tax character of each balance has to be provable later.
Related
401k is the account being left behind and what to check inside it. Expense ratio is the number that usually justifies the move. And the backdoor Roth is the door a pre-tax rollover can close.
The one thing worth pausing over is whether you might ever want to do a backdoor Roth. Rolling a large pre-tax balance into an individual account is easy, sensible on fees, and quietly closes that door for as long as the balance sits there — which is a consequence almost nobody is told about at the moment they consolidate.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.