Should You Roll Your 401k to an IRA?
1.More Investment Choices
Most likely, your 401(k) investment choices are limited to a menu of mutual funds from one particular provider. However, with an IRA, you have the option to invest anywhere. And, you’re likely to have more types of investments from which to choose such as individual stocks, bonds, and exchange traded funds (ETFs). You won’t be limited to mutual funds.
In an IRA, you can also buy and sell your portfolio holdings any time you want. Limiting the number of times you can rebalance your portfolio or go to cash is common to most 401(k) plans. Some even restrict transactions to certain times of year.
2. Better Communication
Whether you change jobs or retirement and leave your account with your old employer, you may be out of the communication loop because you will not be physically present for open enrollment presentations. Sometimes, it may be more difficult to receive updates regarding the plan or speak with an advisor or administrator.
Having ready access to information is extra important in the unlikely event your former employer experiences a downturn.
3. Reducing Fees and Expenses
Rolling your money over into an IRA may lower the management and administrative fees on your retirement account, which may increase your investment returns over time.
You shouldn’t assume that the funds offered by the 401(k) plan are the low-cost option. The funds may be more expensive than similar funds found on the open market. You may also be paying an annual fee to the financial institution in charge of the plan.
It is also possible that you are paying transaction costs and may be subject to 12b-1 fees, or loads associated with mutual funds.
However, it is also possible that your employer may offer institutional-class funds that charge lower fees than their retail counterparts.
And of course, your IRA will have fees and the investments may have expenses as well. The difference is that you are in control, and you will have more choices in how you invest, where, and the fees you are paying.
4. Roth IRA Conversion Options
An IRA rollover opens up the possibility of converting your account to a Roth IRA.
Why consider a Roth IRA? With Roth IRAs, you pay taxes on the money you contribute at the time you contribute it, but the growth and withdrawals are tax-free. This is the opposite of a traditional IRA or Traditional 401(k). Nor do you have to take required minimum distributions (RMDs) at age 72 or ever from a Roth IRA.1
If you believe that you will be in a higher tax bracket or that tax rates will be higher in the future due to our exploding national debt, a Roth Conversion may be the right decision.
If you’re under the age of 59½, it’s also a lot easier to withdraw funds from a Roth IRA than from a traditional one. In most cases, there are no early withdrawal penalties for your contributions, but there are penalties if you take out any investment earnings.2
Many 401(k) plan rules may only permit rollovers to a traditional IRA. If so, you’ll have to rollover your plan to an IRA and then convert the traditional IRA into a Roth. The special sauce is in the timing and amount to convert your traditional IRA to a Roth IRA.
Some of this involves your income and tax rates. You can also make lemons into lemonade when the market experiences a significant downturn by converting assets inside a traditional IRA that is down to a Roth to pay lower taxes at the time of the conversion. If you plan to hold the investments until they recover, that could be an attractive strategy.
But this can be tricky, and it’s best to measure twice and cut once. Be sure to use a firm that gives both investment AND tax advice to ensure that you are optimizing this strategy and avoid tax missteps.
5. Tax Control
The tax rules on your 401(k)’s rules can be complex because employers can choose how they set up their plans. In contrast, IRA regulations are standardized by the Internal Revenue Service (IRS). An IRA at one financial institution follows substantially the same rules as one at any other.
An often-overlooked difference between a 401(k) and an IRA has to do with IRS rules regarding taxes on distributions. The IRS requires that 20% of distributions from a 401(k) be withheld for federal taxes.7 When you withdraw from an IRA, you are free to withhold 10%, 20%, or no taxes. You can select the amount based on what you will owe according to your tax situation. It’s up to you because you are accountable for your taxes in the end.
6. Estate Planning Benefits of an IRA
Most 401(k) plans only allow for a lump sum payment to your beneficiary upon your death. This can cause income and inheritance tax headaches. Rules vary from company to company, but most prefer to distribute the proceeds quickly because they do not want to be responsible for tax reporting for a beneficiary who is electing to take the funds out over 10 years.
The SECURE ACT of 2019 set up the 10-year rule for beneficiary IRA’s. Under this rule, the value of the inherited IRA needs to be zero by Dec. 31 of the 10th Anniversary of the owner’s death. So, person who inherits the IRA has 10 years to withdraw funds. This gives them flexibility on when and how much they withdraw in contrast to many 401(k)’s.
How to Roll Over Your 401(k) to an IRA
The easiest and safest way to roll over your 401(k) into an IRA is with a direct rollover from the your 401(k) plan to the financial institution that will be holding your IRA. Your IRA provider can guide you through the process, and it is smart to involve them every step of the way.
What Are the Advantages of Leaving My 401(k) With My Ex-Employer
You might consider leaving your 401(k) with your ex-employer if you believe the plan is well run, its expenses are reasonable, and you don’t want the responsibility of managing the money yourself. However, make sure you don’t lose track of the account over the years and that the plan administrator always has your current address.
Note, also, that this doesn’t have to be an all-or-nothing decision. You may be able to keep some of your balance in your old 401(k) and roll the rest into an IRA. After that, you can contribute to both your new company’s 401(k) and your IRA as long as you don’t go over the annual contribution limits.
- Internal Revenue Service. “Roth Comparison Chart.” Accessed Nov. 25, 2021.
- Internal Revenue Service. “Rollover Chart.” Accessed Nov. 25, 2021.
Echelon Financial is a member firm of The Fiduciary Alliance, LLC which is an Investment Adviser registered with the Securities and Exchange Commission. The Fiduciary Alliance’s business operations, services, and fees is available at the SEC’s investment adviser public information website www.adviserinfo.sec.gov or from The Fiduciary Alliance upon request.
