When you leave your work, you’ll have three options when it comes to your 401k. They are to 1) Leave the funds with your old employer, 2) Roll it into your present employer and 3) Roll it into a rollover IRA with a brokerage firm. A rollover IRA offers more investment choices, less fees, ability to consolidate and is simpler to manage than 401k plans.
A Rollover IRA is an account that allows you to transfer your employer sponsored retirement plan such as 401k and 403b into an IRA. You still keep your funds tax-deferred and do not pay penalties when you roll over the funds.
Reasons to Rollover your 401k to an IRA
More Investment Choices
The best reason to rollover your 401k to an IRA in a brokerage account is for more choices. Most 401k/ 403b have limited investment options in the form of selected mutual funds. With an IRA, you have thousands of choices in the form of ETFs (exchange traded funds). You can invest in various sectors including communication, consumer discretionary, consumer staples, energy, financials, health care, industrials, information technology, materials, and real estate. The newest ETFs includes autonomous technology & robotics (ARKQ) and Self-Driving EV (IDRV). You can also invest in individual stocks. Your choices are limitless.
In contrast, you may not want that many choices and prefer to have a dozen basic funds to choose from. In this case, you have nothing to lose by keeping your money in a 401k.
Fees and Costs
As mentioned earlier, majority of 401k plans have mutual funds. Fees and costs are generally higher with mutual funds due to management costs. If these fees cost in excess of 1% of your total asset per year, it can add up quickly and will lessen your overall return. Purchasing index funds and individual stocks within an IRA have lower costs. In either case, make sure you read the perspectives and invest in funds with a low fee.
Better Communication
It may be difficult to communicate with an advisor or administrator about your 401k at work. In contrast, a reputable brokerage firm such as Fidelity or TD Ameritrade (now Schwab) have a lot of advisors who are immediately available to talk to you. They may even assign a personal advisor to you depending on how much you invest with them.
Consolidation
You may have 401k with several employers from previous jobs. By rolling over your 401k plans into one IRA, you’ll be able to manage the fund as a whole. Most people I know rarely look at their 401k account. If you have multiple accounts, the chances are higher that they will go ignored and therefore unmanaged. Having a rollover IRA, Roth IRA and after tax fund all under one account makes it simpler. You can track the growth, calculate your net worth from one account. It will also make it easier to figure out the RMD (required minimum distribution) when it’s time to withdraw your funds.
Roth IRA
You can convert portion of your 401k into a Roth IRA when you do a rollover IRA. You will have to pay taxes at federal income tax bracket when you do this so be cautious. If you are retiring, wait until you are no longer working to minimize taxes owed. Roth IRA has many perks including not having a RMD like a 401k/ 403b and traditional IRA.
Reasons Not To Rollover Your 401k
Borrow Money
Depending on what your employer’s plan allows, you can borrow as much as 50% of your savings up to a maximum of $50,000 within a year. You pay yourself and the interest over a period of time. This may give you peace of mind especially if you don’t have an emergency fund set aside.
On the contrary, having your money in an IRA will protect you from yourself. After all, the purpose of a retirement fund is to generate savings for retirement.
Protection From Creditors
The money in your 401k plan is protected from creditors and from bankruptcy whereas an IRA is protected from bankruptcy only. If you anticipate having problems with creditors, you may want to leave your money in a 401k plan.
Rule of 55
IRS guideline allows you to tap into your 401k as early as age 55 under certain circumstances. An employee who is laid off, fired, or quits a job between ages of 55 and 59 1/2 to withdraw from 401k without the 10% penalty. Depending on your employer’s plan administrator, this may or may not be easy to do.
Putting it Together
Learning and understanding the advantages and disadvantages of rolling over your 401k/ 403b to an IRA, leaving it with your previously employer or transferring it to your current employer depends on your financial situation, where you are in your career, your age and your preferences.
When it comes to growing your nest eggs, remember these two rules:
- Earn more than you spend and
- Invest wisely