If you’ve recently changed jobs, you may be considering what to do with your existing 401(k). One option is to roll it over into your new employer’s plan. Another is to move it into an Individual Retirement Account (IRA).
While both choices have benefits, rolling your 401(k) into an IRA often provides more flexibility, a wider array of investment options, and potential tax advantages.
Understanding these benefits can help you make an informed decision and position your retirement savings for maximum growth.
Expanded Investment Options
401(k) plans are typically limited in their investment choices.
Most employer-sponsored plans offer a pre-selected list of mutual funds, often favoring large-cap stocks, target-date funds, and a few bond options. Many of these options are in high-fee, actively managed mutual funds.
With an IRA, you can access a wider range of investments, including, bonds, ETFs, and REITs. These choices allow you to diversify your retirement portfolio more effectively. Greater diversity can enhance your growth potential while helping reduce risk, especially when markets are volatile.
The ability to diversify also means tailoring your IRA to match your specific financial goals and risk tolerance. If you’re nearing retirement, you might choose more conservative investments to help preserve your savings. If retirement is still a couple of decades away, you may focus on growth-oriented assets that could yield higher returns over time.
Control Over Fees
401(k) fees are often less transparent than those associated with IRAs, making it harder to gauge how much of your returns are eroded by administrative costs.
Employer-sponsored plans typically charge fees for plan administration, recordkeeping, and investment management. These fees can vary significantly from one plan to another which can erode your returns over time.
Rolling your 401(k) into an IRA offers more control over these costs. With an IRA, you can choose low-cost index funds and ETFs, potentially lowering your overall fees. By minimizing fees, you retain more investment gains, which can substantially affect your retirement balance.
Streamlined Account Management
You may have several 401(k) accounts if you’ve worked for multiple employers. Keeping track of multiple retirement accounts can become cumbersome, especially as each plan may have its rules, fees, and investment options.
Consolidating these accounts into a single IRA simplifies your account management.
A consolidated IRA makes it easier to rebalance your portfolio and ensures you stay on top of your investments. Having a single account can also simplify tracking your overall retirement savings progress, which is vital for ensuring you’re on pace with your retirement goals.
Withdrawal Flexibility
Traditional IRAs generally offer more flexible withdrawal options compared to 401(k) plans. Here are a few key differences:
- Early withdrawal penalties: Both traditional IRAs and 401(k) plans impose a 10% early withdrawal penalty for distributions taken before age 59½. However, IRAs have more exceptions that allow for penalty-free withdrawals. For example, you can withdraw up to $10,000 from a traditional IRA for a first-time home purchase or to cover certain qualified education expenses without incurring the penalty.
- Access to funds: 401(k) plans often have stricter rules around accessing funds, sometimes requiring that you meet certain criteria related to your employment status.
- Loan options: Some 401(k) plans allow you to take loans against your balance, which is not an option with traditional IRAs. While loans can provide immediate access to funds, they also come with the risk of triggering tax implications and penalties if not repaid in a timely manner.
- Substantial equal periodic payments (SEPP): While both account types can allow for penalty-free withdrawals under the SEPP rule, the specifics can vary. With IRAs, you can set up these distributions to avoid the early withdrawal penalty, providing a steady stream of income in certain scenarios.
You cannot use a SEPP plan with a 401(k) you hold with your current employer.
Avoid Mandatory Distributions if You Keep Working
With a 401(k) plan, you are generally required to begin taking required minimum distributions (RMDs) at age 72 (73 if you reach age 72 after December 31, 2022), even if you’re still employed. Some employer plans waive this requirement for employees who continue working past this age.
Roth IRAs are free from RMDs during your lifetime. This difference means you can let your savings grow tax-free, potentially maximizing the amount available in retirement.
If you plan to keep working into your seventies, rolling over your 401(k) into a Roth IRA can provide the flexibility to delay distributions, leaving more assets in place to grow for future years or as a legacy for beneficiaries.
Ease of Beneficiary Designations and Estate Planning
IRAs (especially Roth IRAs) offer advantages for estate planning.
Many employer-sponsored 401(k) plans have strict rules regarding beneficiary designations, often defaulting to the spouse or requiring spousal consent for other designations. While this isn’t necessarily a drawback, IRAs provide more flexibility for designating beneficiaries according to your wishes.
An IRA gives you more control over how your assets will be distributed after your death. For example, beneficiaries of an inherited IRA have options for stretching distributions over a ten-year period after the death of the account owner, potentially easing their tax burden.
Rolling your 401(k) into an IRA can also simplify the process for your heirs by consolidating your retirement savings into a single account, making it easier for them to manage your legacy.
Enhanced Portability
If you change jobs again in the future, an IRA spares you from having to decide what to do with yet another 401(k) account. With an IRA, your retirement account stays with you, regardless of where you work. This means you can continue contributing to and managing the same account, adding a layer of continuity to your retirement planning.
Enhanced portability also enables you to align your retirement savings strategy, regardless of career changes. Instead of transferring assets each time you start a new job, an IRA stays in place, simplifying your overall retirement strategy.
Increased Access to Professional Advice
IRAs are generally easier to manage with financial advisors, who can offer tailored advice based on your complete financial picture. While some 401(k) plans provide basic advisory services, the guidance is often limited to plan options without considering your overall financial situation.
When working with an advisor on an IRA, you benefit from customized strategies, tax planning, and investment management that reflect your specific goals and circumstances.
Access to professional advice can significantly impact you, especially when fine-tuning your asset allocation, navigating tax-efficient strategies, and preparing for distribution phases. An advisor can also assist in areas like Roth conversions, which could be beneficial depending on your tax situation.
Final Thoughts
Rolling over your 401(k) into an IRA instead of a new employer plan offers benefits like broader investment options, reduced fees, and greater control over your retirement savings.
An IRA provides more flexible withdrawal rules, advantageous tax strategies, and simplified estate planning.
For many, this approach can create a streamlined and personalized retirement strategy that aligns with current goals and future needs. Weighing these factors carefully can help maximize your retirement savings and build a secure financial future.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual. All investing involves risk, including loss of principal. No strategy ensures success or protects against loss.