Here’s What Happens During a Direct 401(k) Rollover

There may come a point when you decide that it's time to leave your job and move on to another one. And there are some key items you'll need to address in that scenario.

First, you'll need to make sure you're eligible for health coverage at your new job right away, or otherwise figure out what you'll do for health insurance during that transition. You'll also need to check your overall benefits package to see if it makes sense to sign up for perks like a health savings account.

Another item you'll need to tackle is your retirement plan. If you have money in a 401(k) and you're leaving your job for a new one, it's generally a good idea to move that money into a new retirement account rather than leave it where it is. And if your new job offers its own 401(k) that you're eligible for immediately, doing a direct rollover could be a good bet.

How a direct 401(k) rollover works

With a direct 401(k) rollover, the money in your old 401(k) is transferred directly into your new 401(k). You can also do a direct rollover from a 401(k) into an IRA. This is a good option to look at if your new employer doesn't have a 401(k) or you're not eligible to participate in it right away.

But not all 401(k) rollovers are direct, and sometimes, even if you ask for one, you'll be told that your only option is to do an indirect rollover. This is a less ideal route to take, because if you don't follow the rules carefully, you could end up with a penalty on your hands.

With an indirect rollover, you receive a check for your old 401(k) balance. It's then on you to deposit that money into another qualified retirement plan, such as a new 401(k) or an IRA. If you don't get that money deposited within 60 days, it will be treated as a withdrawal from your 401(k). And that could be problematic if you're not yet 59½. In that case, you'll risk a 10% early withdrawal penalty.

Plus, if you're moving funds from a traditional 401(k) to another traditional 401(k) or IRA, as opposed to a Roth IRA or 401(k) account, and you don't deposit that money into your new plan in time, your withdrawal will be subject to taxes.

Are you better off not doing a rollover at all?

Generally speaking, it's not a great idea to leave retirement funds in an old employer's plan. Doing so could increase your chances of forgetting about that money, which you don't want.

As such, a rollover is generally your best bet when you're leaving a job, and if you can do a direct rollover, even better. That saves you the hassle of having to get involved in the process of moving your money over, not to mention the potential for a penalty if your transfer doesn't get completed in time.