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How to roll over a 401k to an IRA

You can avoid costly mistakes by following these simple steps.

By MSN Money Partner Jul 15, 2011 5:34PM

This post comes from partner blog The Dough Roller.

 

Last week we looked at whether you should roll over your 401k to an IRA when you leave a job. Having left my job a month ago, I've decided to go forward with a 401k rollover and transfer the retirement account to an IRA.

 

The good news is that rollovers are really easy to do. You do have to be careful, however, to avoid a few traps that could cost you a small fortune. (I'll cover those traps below).

 

A 401k rollover requires just two steps:

  • Decide where you want to open your rollover IRA account.
  • Initiate the transfer of your retirement account from your 401k to the new IRA.

Let's take a look at each of these steps in some detail.

 

Rollover options

Before you can roll over a 401k, you must first open the correct type of IRA account. There are several options here, and the two most popular choices are a brokerage account and a mutual fund account.

 

Brokerage account. Transferring a 401k to a brokerage account is ideal if you want to invest in a variety of stocks, bonds and ETFs. Discount brokers now charge just a few dollars for equity trades, and most rollover IRA accounts have minimal if any fees. Having used Scottrade for my SEP IRA, I can attest to just how easy it is to buy and sell investments online.

 

As you review the best options for your retirement account, you'll want to consider several factors. First, make sure the broker offers the type of IRA account you need. If you are opening a standard rollover IRA, you will find that every major online broker offers this type of account. For specialty IRA accounts, like a SEP IRA, however, you'll find many brokers that do not offer that type of account.

 

Second, you'll want to evaluate fees. The fees to consider include both account maintenance fees and trading fees. Given the competition today among brokerage firms, you will find many low-fee options. (Are you saving enough for retirement? Try MSN Money's calculator.)

 

Third, you'll want to look at the trading tools. Many online brokers now offer virtual trading accounts, where you can practice trading without putting your money at risk. The best brokers also offer video tutorials on everything from evaluating stocks to trading options.

 

With those factors in mind, here are several top-rated brokers to consider:

  • Scottrade. I have an IRA with Scottrade and have been very happy with it. Scottrade is arguably the most feature-rich online discount broker available. In addition to an online brokerage, Scottrade offers physical locations throughout the U.S. The only downside to Scottrade is that its online trading platform is very Web 1.0. From a look and feel perspective, it needs some updating. But in terms of performance, Scottrade executes trades as fast or faster than any other broker.
  • optionsXpress. It's the Cadillac of online brokers and, like a Cadillac, it's not the least expensive. But it comes with arguably the best trading tools you'll find anywhere. As a result, optionsXpress has won just about every award out there for online investing.
  • OptionsHouse. If you are looking for low cost, OptionsHouse is arguably the best choice. There are no maintenance fees, OptionsHouse will pay up to $125 in fees for the 401k rollover, and its commissions are at rock-bottom prices. For example, stock trades are a flat $3.95.

Mutual funds. You can open a rollover IRA directly with a mutual fund company. I have one with Vanguard. A mutual fund IRA is the perfect choice if you plan to invest only in mutual funds and ETFs offered by one mutual fund company. Why? Because the fees will be the lowest you can find. If you want to invest outside of a single mutual fund company, however, a brokerage account is the better option.

 

If you want more information on mutual fund IRAs, check out Fidelity and Vanguard. Post continues after video.

How to initiate the 401k rollover

After you've decided where to open your IRA, the next step is to initiate the rollover. Here are the steps I've taken:

  • Call your 401k administrator. The very first thing I did was call my 401k administrator. My 401k was handled by Fidelity, so a call to customer service provided me with all the information I needed. The key questions to ask are whether there are any fees for rolling over a 401k and what forms you need to initiate the transfer. You can also speak with the person at your former employer who handles retirement accounts, but in my experience, they will end up referring you to the company that manages the 401k.
  • Call your IRA administrator. Whether you've chosen a brokerage or mutual fund company for your new IRA, I'd highly recommend calling them too before initiating the transfer. I like to confirm what they need to complete the transfer.
  • Initiate a direct transfer. There are two ways to roll over a 401k into an IRA -- direct transfer and via check. I've always used the direct transfer method. It's easier as you never have to handle a check, and it avoids the possibility of the IRS deeming you to have taken a distribution from your 401k (triggering taxes and potentially a 10% penalty).

Once you initiate the transfer, keep an eye on your accounts to make sure the rollover occurs without a hitch. These can take a few business days, and it always makes me nervous. Once the transfer is complete, your 401k rollover is complete and you're good to go.

 

More on The Dough Roller and MSN Money:

2Comments
Jul 16, 2011 7:46PM
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      Indeed, if you make a conversion, there will be tax consequences.  However, this article is not about "conversions" -- it's about "rollovers," which moves the money to another account while maintaining the tax-deferred status.  About 8 years ago I followed the same steps as outlined by "Dough Roller," and there were no tax consequences, and there were no problems.
       I called my 401k administrator at Fidelity and asked for a "trustee-to-trustee" transfer.  They sent me a check for the full amount, which had Scottrade's name on it.  I took the check to Scottrade and they put it into an "IRA Rollover" account in my name.  The only amounts that have been taxed are what I've been "converting" to a Roth IRA each year.
Jul 16, 2011 1:30PM
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You forgot to mention the tax consequences of the conversion.  These can be very costly and can outway the benefit of being able to trade freely on line.  Before anyone converts their retirement accounts they need to consult a professional tax person.  Depending on their age, it can cost them up to 35% of their investment.  Shame on you for making it sound soooooo simple.  
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