Here's What Happens When You Roll an Old 401(k) Into an IRA

When you work for a company that offers a 401(k) plan, it can often make sense to participate. Not only is funding a 401(k) plan a great way to save money on taxes in the course of socking money away for retirement, but you might end up snagging free money in your account. That's because many companies that offer 401(k)s also match worker contributions to varying degrees.

But what if the time has come to leave your job? If so, you may have the option to leave your 401(k) where it is. But a better bet is generally to roll that money into a new retirement plan.

Now if you've already gotten a new job and know you'll have access to a 401(k) plan through your future employer, then rolling your old 401(k) into that new 401(k) could make sense. But if you're not sure whether you'll have access to a new 401(k), then it generally pays to roll an old 401(k) into an IRA.

You don't want to forget about that money

When you leave an old 401(k) alone, you run the risk of losing it. And if you're thinking "there's no way I'll forget about my money," know this. Capitalize estimates that there are a good 29.2 million forgotten 401(k)s holding about $1.65 trillion in assets. Wowza. So if you're leaving a job, it pays to roll your old 401(k) into a new retirement plan.

When you do a rollover to an IRA

There are two ways to roll a 401(k) into an IRA. One is to do a direct rollover, where your money transfers from your old retirement account to your IRA so you never get a chance to touch it. The other is to do an indirect rollover, where you get a check for the balance of your 401(k) and it's on you to deposit those funds into your IRA.

If you're given the choice, a direct rollover is generally your best bet. That's because a direct rollover ensures that your money will land in your IRA as it's supposed to.

With an indirect rollover, you only get 60 days to move the funds from your old retirement plan into a new one. If you don't deposit those funds in time, the money you've received from your old plan will generally be treated as a distribution.

If you're not yet age 59 ½, an IRA or 401(k) distribution will be subject to a 10% early withdrawal penalty. Plus, you might face taxes on your distribution right away if your money is in a non-Roth account. You really don't want either of these things to occur.

Many people who leave a job with a 401(k) opt to roll that money into a new 401(k). But if that's not an option for you, you can always roll an old 401(k) into an existing IRA or a new one you open. But either way, be careful about doing that rollover, because you don't want to risk a scenario where you end up facing taxes and penalties in the course of moving your retirement savings around.