Find out the benefits and drawbacks of having your 401(k) and IRA in order.
Some advantages of combining all of your retirement accounts into one IRA include:
When you leave a job, you’re faced with a crucial decision: what to do with your 401(k) savings. The conventional wisdom is to roll it over into an individual retirement account (IRA), but there are situations where keeping your 401(k) with your former employer might be the better option.
This article explores five compelling reasons why you might want to reconsider rolling over your 401(k) to an IRA:
1. Greater Buying Power:
Company 401(k) plans often have access to institutional pricing rates for investments, which can lead to significant cost savings compared to IRAs. This means more money can be invested and potentially grow over time.
2. Tax Savings:
If your 401(k) includes appreciated company stock, transferring it to a regular brokerage account instead of an IRA can offer significant tax advantages. You’ll only pay taxes on the original purchase price of the stock, not on any gains, until you sell it. This can be a substantial benefit, especially if the stock has significantly increased in value.
3. Legal Protection:
Funds held in a 401(k) are shielded from most types of creditor judgments (except for IRS tax liens and potentially spousal or child support orders) under federal law. This protection is stronger than the state-level protection offered to IRAs, which can vary significantly depending on your location.
4. Early Retirement Benefits:
With a 401(k), you may be able to access your funds as early as age 55 without incurring the 10% early withdrawal penalty that applies to IRAs before age 59½. This can be a valuable option if you need to access your retirement savings before reaching the traditional retirement age.
5. Stable Value Funds:
Company 401(k) plans offer access to stable value funds, which are similar to money market funds but typically offer better interest rates. These funds provide a safe haven for your investments while still offering the potential for growth.
Disadvantages of Rolling Over a 401(k) to an IRA
While rolling over your 401(k) to an IRA can be beneficial in many situations, there are also some potential drawbacks to consider:
- No Loan Options: Unlike some 401(k) plans, IRAs typically do not allow you to borrow against your retirement savings.
- Decreased Creditor Protection: As mentioned earlier, IRAs offer less protection from creditors compared to 401(k) plans.
- Potentially Higher Fees: Depending on the IRA provider you choose, you may face higher fees than you did with your 401(k) plan.
- Loss of Early Withdrawal Without Penalty: Rolling over your 401(k) to an IRA means you lose the ability to access your funds before age 59½ without incurring a penalty.
Should You Roll Over Your 401(k)?
The decision of whether or not to roll over your 401(k) to an IRA depends on your individual circumstances and financial goals. Carefully consider the advantages and disadvantages outlined above and consult with a financial advisor to determine the best course of action for your situation.
Frequently Asked Questions
Q: Can I roll over my 401(k) to an IRA without penalty?
A: Yes, you can roll over a 401(k) to a traditional IRA without incurring any penalties or tax consequences. However, if you roll over your 401(k) to a Roth IRA, you will be responsible for paying taxes on the amount rolled over.
Q: How much does it cost to roll over a 401(k) to an IRA?
A: Typically, there are no fees associated with rolling over a 401(k) to an IRA. However, you may incur fees depending on the IRA provider you choose and the specific investment options you select.
Q: What are the advantages of rolling over a 401(k) to an IRA?
A: Rolling over your 401(k) to an IRA can offer several advantages, including:
- Greater investment flexibility: IRAs typically offer a wider range of investment options than 401(k) plans.
- Lower fees: Depending on the IRA provider you choose, you may be able to find lower fees than those associated with your 401(k) plan.
- Consolidated retirement savings: Rolling over multiple 401(k) accounts into a single IRA can simplify your retirement planning and make it easier to track your investments.
Q: What are the disadvantages of rolling over a 401(k) to an IRA?
A: The potential disadvantages of rolling over a 401(k) to an IRA include:
- Loss of loan options: Unlike some 401(k) plans, IRAs typically do not allow you to borrow against your retirement savings.
- Decreased creditor protection: IRAs offer less protection from creditors compared to 401(k) plans.
- Potentially higher fees: Depending on the IRA provider you choose, you may face higher fees than you did with your 401(k) plan.
- Loss of early withdrawal without penalty: Rolling over your 401(k) to an IRA means you lose the ability to access your funds before age 59½ without incurring a penalty.
Rolling over your 401(k) to an IRA can be a smart move, but it’s essential to weigh the advantages and disadvantages carefully before making a decision. Consider your individual circumstances, financial goals, and risk tolerance to determine the best course of action for your retirement savings.
Disadvantages of an IRA rollover
A rollover is not for everyone. A few cons to rolling over your accounts include:
- Creditor protection risks. If you leave money in a 401(k), you may be protected from creditors and bankruptcy, as state-specific IRA regulations govern protection from creditors.
- Loan options are not available. The funds may be less accessible. An employer-sponsored 401(k) account might be able to lend money to you, but an IRA will never allow you to do so.
- Minimum distribution requirements. In general, you can withdraw money from a 401(k) without incurring an early withdrawal penalty (as of 2010) if you leave your employer before the age of 55. When you have an IRA, you usually have to wait until you are at least 2% older than the minimum age of 2029%201 to withdraw money in order to avoid an early withdrawal penalty from 2010 The Internal Revenue Service provides a rollover chart and additional details on various tax scenarios.
- More fees. When compared to a 401k, which has access to institutional investment funds at a lower cost due to group buying power, you might be paying higher account fees.
- Tax rules on withdrawals. If company stock makes up part of your 401(k) investment, you might be qualified for advantageous tax treatment upon withdrawal.
You can manage your investment mix, change your risk tolerance, and even purchase individual stocks or bonds with an IRA. Instead of purchasing the same holdings in every account, you can use the “asset location” strategy, which places less tax-efficient investments in your IRAs and more tax-efficient investments in your taxable accounts. When the time is right, you can rebalance your portfolio and choose which investments to sell to free up cash for withdrawals.
More control, better investment options, and access to more sophisticated tax strategies can be obtained by rolling over a 401(k) into an IRA. Additional benefits include improved communication, streamlined recordkeeping, and estate planning advantages. But there are also possible disadvantages to take into account, like restricted fund access, increased fees in certain situations, loss of creditor protection, loss of the “backdoor Roth” strategy, and less advantageous treatment for NUA Before making a decision, it’s critical to assess your unique situation and weigh all of your options. To choose the best course of action for your retirement savings, speak with your Wealth Management team and a tax expert.
You can convert certain shares or dollar amounts by moving them straight from your IRA to your Roth IRA after your 401(k) has been rolled over to your IRA. The best times to pursue Roth conversions are frequently after retirement and before you begin receiving Social Security benefits. Additionally, for those over age 70. 5. You are able to take out tax-free money from your IRA to give to charity. These options are not available in a 401k plan.
Although transferring a 401(k) to an IRA can be a smart move, it’s crucial to consider the advantages and disadvantages first. Employer-sponsored retirement plans, or 401(k)s, enable workers to invest and save a portion of their income tax-deferred. In contrast, individual retirement accounts, or IRAs, are tax-advantaged investment accounts that people can open on their own to begin saving for retirement. You have several options when it comes to what to do with your 401(k) after leaving an employer: you can roll it over to an IRA, maintain your assets in the current plan, roll your assets into a new employer’s 401(k) plan, or take a fully taxable distribution of your plan’s assets.
After you rollover your 401(k), this tactic might not make sense if you want to continue contributing to your Roth IRA through the “back door” while you are still employed. By making an annual non-deductible contribution to your traditional IRA and converting the full amount to your Roth (which is usually tax-free if done correctly), you can use the “back door” Roth IRA strategy. After you roll over your 401(k), this strategy might not be beneficial any longer because 401(k) funds are normally pre-tax. They will be taken into account in the pro-rata computation that establishes the taxable portion of your Roth conversion after they are rolled into your IRA.