Can You Roll Over a 401(k) Into a Self-Directed IRA?
A self-directed IRA (SDIRA) allows individuals to take charge of their retirement savings by directly managing their own investments. In addition, SDIRAs offer flexibility to investors, giving them the ability to own alternative assets, such as private equity funds, private debt, investment real estate, and shares of private companies, in a qualified retirement account.
In this article, we present several different options for funding SDIRAs, including Transfers and Rollovers, with a focus on rolling over a 401(k) account into a SDIRA. We also give an overview of what you need to know if you’re considering a 401(k) Rollover — from rules and regulations to potential penalties.
Self-Directed IRAs: A Quick Recap
A self-directed IRA is a type of retirement account that permits investors to hold alternative assets, in addition to publicly traded stocks, bonds, and exchange-traded funds (ETFs). For example, alternative investments may offer the possibility of higher returns (though often with higher risks) and meaningful diversification, as alternative assets don’t always move in the same direction as public stocks and bonds.
As we explained in a previous article, self-directed IRAs can appeal to people who prefer the DIY (“Do It Yourself”) approach to investing their retirement assets. SDIRAs require a custodian (such as Forge Trust) to administer the account. However, it’s important to note that while you can designate a personal advisor, a SDIRA custodian cannot provide an investor with advice or guidance.
There are several types of IRA accounts.1 For example, with a Traditional IRA, contributions are generally tax-deductible, though the IRS has a number of rules and regulations that you must follow.2 In the case of a Roth IRA, contributions are made with after-tax dollars, but qualified withdrawals are tax-free provided you meet specified IRS guidelines for Roth IRAs.3 And with both Traditional and Roth self-directed IRAs, capital gains and income accumulate tax-free so long as they remain in the accounts.4
Understanding 401(k)s and Their Popularity
Chances are the term 401(k) rings a bell. A 401(k), named for a section of the tax code, is a defined contribution (DC) retirement plan provided by an employer.5 As many companies no longer offer pension plans6 — known more formally as defined benefit (DB) plans — DC plans have become increasingly important for retirement savers. What sets a 401(k) apart from other DC plans is that employers often match a portion of employee contributions. A similar kind of plan for non-profit and government workers, the 403(b), allows employer matching as well, but this practice is not as common as in 401(k) plans.7
The potential for employer matching is one major reason why 401(k)s are so popular. And popular they are: According to the Investment Company Institute (ICI), more than 70 million Americans participate in 401(k)s. Collectively, these plans held approximately $6.9 trillion in assets as of September 30, 2023.8
Yet despite the popularity of 401(k)s, many people seek more freedom when it comes to how they can invest their retirement savings. With a 401(k), employees are restricted to choosing from a menu of investments (such as mutual funds) provided by the plan administrator. That’s why a Rollover SDIRA may be attractive.
Rollovers and Transfers, Explained
As we discussed in an earlier article, self-directed IRAs can be funded via either Rollovers or Transfers. And while they’re similar in nature, there are important differences between the two approaches. With a Transfer, funds are moved from one individual retirement account to a self-directed IRA. Generally, no taxes will be withheld when completing a Transfer, provided that the funds are sent directly from one trustee to another,9 though you should always consult your tax professional or financial advisor before starting the process.
Rollovers are different than Transfers. Rollovers involve rolling over cash or assets previously held in an employer-sponsored plan — such as a 401(k) — into an IRA. Retirement savers can elect to do either a direct or indirect Rollover. With a direct Rollover (the simplest option), you open a SDIRA with a new custodian (such as Forge Trust) that offers these accounts. Then to move the funds, you would first complete any forms your current 401(k) plan administrator requires in order to prepare the funds to move your new plan. After all the paperwork is completed, your current plan administrator would send the funds — usually via a check or wire — to your new custodian.
To do an indirect Rollover, you can request and receive funds from a previous employer-sponsored plan, such as a 401(k). You then have 60 days from when the check or wire was issued to deposit the funds into an IRA or self-directed IRA account. If funds rolled over from an employer-sponsored plan are deposited with an IRA custodian within the 60 days, you preserve the tax-deferred status of the assets and avoid early withdrawal penalties. Keep in mind, however, that 20% of the total amount you request from your employer is subject to withholding. That said, you do have the option of making up and contributing the 20% to your new plan, though it’s necessary to fully understand the IRS rules for indirect Rollovers to potentially avoid unwanted consequences.10 We advise that you consult with your financial or tax professional before initiating the process.
Rules for Rollovers: Key Things You Should Know
Before going ahead with a SDIRA Rollover, it’s crucial to be aware of the relevant IRS rules and regulations. First, you’ll want to ensure that your current retirement plan is eligible to be rolled over to a new account. According to the IRS, eligible Rollovers are employee balances in employer-sponsored plans, though the IRS outlines a number of exceptions that you need to be aware of before starting the process.11 It’s also important to note that you can only complete one indirect Rollover in a 12-month period.
As previously mentioned, a direct Rollover is the simplest method to avoid 20% of the funds issued directly to you from your employer-sponsored plan being subject to withholding tax. In addition, it’s important to be aware that if you are under the age of 59½ when you receive the funds directly, you may be subject to an additional 10% tax on any taxable amounts not rolled over into your SDIRA.
Conclusion
While Rollovers are a popular choice for funding SDIRAs, the Rollover process can sometimes require significant effort. For assistance in rolling over your 401(k) or other retirement plan funds into a self-directed IRA, Forge Trust has partnered with a third-party provider that can make the process much smoother.
Frequently Asked Questions on 401(k) Rollovers
Can you roll over a 401(k) to a self-directed IRA?
Yes. In fact, rolling over a 401(k) to a self-directed IRA is often attractive for individuals who value the freedom to make their own investment decisions. By rolling over a 401(k) into a SDIRA, you can hold a wider range of assets — including alternative investments such as private equity funds, investment real estate, private company shares, and precious metals — in addition to public stocks and bonds.
Can you fund your SDIRA with your 401(k)?
Yes. To fund your SDIRA, you can do a direct or indirect Rollover of your 401(k) plan. However, many employers do not permit current employees to roll over a 401(k) to any IRA plan while the employee is still with the company.12
Can you roll a 401(k) into a self-directed IRA without penalty?
Yes, it’s possible to roll a 401(k) into a self-directed IRA without penalty. The easiest way is as a direct rollover. However, it’s imperative that you follow all IRS rules to avoid potential penalties. We strongly recommend you consult your financial or tax professional before starting the process.
Can you roll over a 401(k) to a self-directed IRA if your company terminates its 401(k) plan?
Yes, if your company terminates its 401(k) plan, you can roll over your assets from that plan into a self-directed IRA through a direct or indirect Rollover. We strongly recommend you consult your financial or tax professional before starting the process.
Zander is a seasoned product leader with a 12-year history in financial technology, specializing in private market investments. His tenure includes roles at LTSE, Alto, and IHS Markit, where he focused on product management and strategy. Zander holds an MBA from Vanderbilt University, focusing on International Business, and a B.A. in Economics from Colby College.