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Investing Specialists

A 401(k) Rollover Checklist

Is deciding what to do with an orphan 401(k) on your to-do list? Here are seven steps for getting it done.

Old 401(k)s are a little like the old clothes in the back of your closet. You know you should do something about them--try them on and see if they still fit (and aren't hopelessly out of style), or donate them to charity. But inertia isn't costing you anything other than closet space, and you know the process of getting everything in shipshape could take a little time. So, there they sit--mostly out of sight and mind.

And so it is with your old 401(k). Thanks to a strong stock market, the periodic statements you receive show that your account balance has probably ticked steadily upward since you left. And while you've heard that you should consider a rollover, you've also heard ominous tales about how you can end up on the hook for a bunch of taxes if you don't follow the rollover rules to the letter. The path of least resistance beckons.

Indeed, a 2009 Charles Schwab study revealed that approximately 30% of employees who have changed jobs leave behind assets in their old 401(k) plans. If the former employer's plan is gold-plated, or even just solid, that's not unreasonable.

But at a minimum, holding multiple retirement accounts here and there means that you have more holdings to monitor. And if the old 401(k) is subpar, you may actually hinder your returns by staying put. The old plan may levy a layer of administrative expenses that you could circumvent by rolling the money over into an IRA, or perhaps the fund choices in the old plan are high cost and second rate.

If deciding what to do with an old 401(k) plan has been on your to-do list for a while, here are the key steps you should take to get it done.

Step 1: Check your account value.
If your balance in your former employer's 401(k) plan is over $5,000, you have a full gamut of options: You can leave the money behind in the old plan, assuming the plan allows it, or roll the assets into an IRA or your new employer's 401(k) (again, assuming the plan permits it). Move on to Step 2.

But if your balance falls below that $5,000 threshold, some of the decision-making may be out of your hands. Whatever you do, make every attempt to avoid pulling the money out of the confines of a 401(k) or IRA; otherwise, you'll pay taxes and a 10% penalty if you're under age 55. This article discusses your options for IRAs under the $5,000 threshold.

Step 2: Determine whether to stay within the 401(k) confines.
Assuming your balance is over $5,000, your next task is to decide whether to roll the money into an IRA or keep it inside a 401(k)--either that of your former employer or that of your current one. Leaving the money behind or rolling it into your current employer's 401(k) may or may not be allowable--the specific bylaws vary by plan, so check on that first.

Because of the layer of fees and subpar, high-cost choices that can sometimes accompany 401(k)s (especially if you work for a small employer), I often recommend rolling over the assets from a former 401(k) into a no-fee IRA with a topnotch mutual fund company or discount broker. You can put almost anything you like within an IRA, and you'll usually be able to avoid any administrative fees if you shop around.

But switching out of the confines of a 401(k) isn't always the right answer. Some people value the extra creditor protections that can accompany 401(k) assets versus IRA assets (specific laws vary by state), while others may prize 401(k)-specific investment options, including stable-value funds and ultra-low-cost institutional share classes.

This article outlines some situations when remaining in a 401(k) is advisable.

If you've determined it's best to stay put in a 401(k), go to Step 3.

If you've decided to roll your 401(k) assets into an IRA, go to Step 4.

Step 3: Assess the quality of your 401(k) options.
If you think you will be better off leaving your money inside of a 401(k) rather than rolling over the money to an IRA, the next job is to conduct some research on your own 401(k) options. It may be that the low quality of the 401(k) overrides the benefits you might get by sticking with it. And even if you do decide to stay with a 401(k), you may need to decide whether you're better off staying put in your former employer's plan or that of your new employer.

This article discusses how to evaluate a 401(k) plan's quality, while this one provides some benchmarks for evaluating your 401(k).

Stop here if, after reviewing its quality, you've decided to remain in your former employer's 401(k). You're done. Inertia was the right answer after all.

Skip to Step 5 if you plan to roll over your old 401(k) into that of your new employer.

Step 4: Find the right IRA provider.
If you've determined that a rollover to an IRA, rather than to your new employer's 401(k), is the way to go, the next step is to identify the right brokerage firm or mutual fund company to house your account. Look for a firm that offers a breadth of high-quality investment options, both stock and bond, with no additional layers of fees for IRA investors.

If you're a fund investor, use  Morningstar's list of "Medalist" funds to help home in on firms with a number of highly rated options. T. Rowe Price, Fidelity, and Vanguard all have a high number of Medalist funds, and Schwab also fields some top-flight index funds. Look for shops with a high number of Medalists across asset classes: U.S. and international stocks and bonds. While bonds might not be a big component of your retirement portfolio right now, they'll take on greater importance down the line.

If you're looking for a broader set of investment choices for your IRA, including stocks or exchange-traded funds, this article outlines some of the key features to look for in a discount brokerage firm. Note that major fund companies such as Fidelity and Schwab also offer brokerage services as well as mutual funds.

IRA investors don't have to stick with mutual funds, exchange-traded funds, and conventional individual securities such as stocks and bonds. They can also invest in commodities, real estate, and other nonpublicly traded assets via what's called a self-directed IRA. But go in with your eyes wide open to the potential risks, as discussed in this article.

Step 5: Decide whether to convert your Traditional 401(k) assets to Roth.
If you've made Roth 401(k) contributions and decide to roll over that money to an IRA or your current employer's 401(k), your new account will be Roth, too, meaning that you won't owe tax on qualified withdrawals.

If you have Traditional 401(k) assets, a rollover is a good time to consider whether to transfer those assets to a Roth account at the same time you do the rollover. This article details some of the key considerations to bear in mind when mulling a conversion from a Traditional IRA to a Roth, and the key factors are nearly identical for rollovers from a Traditional 401(k) to a Roth IRA.

Step 6: Execute.
Once you've decided where you'll steer your old 401(k), it's time to get it done. The process is similar, whether you're rolling over the money into an IRA or your current employer's 401(k).

If you've decided to roll over your assets to an IRA, the first step is to fill out the paperwork or online form to open the IRA. (You can skip this step if you're rolling the money into an already-existing IRA in your name.) You'll then need to request a direct rollover from your 401(k) plan to the new IRA provider. Many fund companies and brokerage firms have rollover kits and rollover specialists to assist you in this process. (Naturally, the firm that's receiving the assets will usually be more helpful than the 401(k) provider.)

The process may be a bit more cumbersome if you're rolling over to your current employer's 401(k). The type and amount of paperwork will vary by 401(k) provider, and there may be a lag time before your balance actually gets deposited into your new 401(k) plan.

In both cases, the key is to have your 401(k) provider make the check payable to the IRA or 401(k) provider and send it directly to them, rather than to you. If the check is made out to you, 20% of the balance will be withheld for income tax. You'll then have 60 days to get that money deposited into an IRA or another 401(k); if that deadline comes and goes, the distribution will count as a withdrawal and you'll owe ordinary income tax and a 10% early withdrawal penalty if you're not 55 or older.

Step 7: Determine what to invest in.
Thus far, we've focused on logistical matters. But if you've decided to roll over your assets from an old 401(k) to another 401(k) or IRA, you'll also have to determine how you'll allocate those assets.

If all of your retirement assets were in your old 401(k), a sturdy target-date fund is a one-stop, low-maintenance choice that you can hold into retirement. The target-date series from Vanguard and T. Rowe Price rate as Morningstar's favorites.

If your old 401(k) is just one of several accounts geared toward retirement, a rollover can be an ideal time to check up on how all of the pieces fit together--and where you have holes. Enter all of your retirement holdings (except the assets in your old 401(k)) into  Morningstar's Instant X-Ray tool, then assess your current asset allocations relative to your targets. No targets? This article provides some guidelines.

See More Articles by Christine Benz