Pros and cons of rolling over 401k to new employer

Overview

One of the primary ways to save for retirement is through your employer’s 401(k) plan. When you change jobs, you’ll have the option to move your 401(k) funds into an Individual Retirement Account (IRA) or keep the money with your former employer. Since retirement readiness is often one of your primary financial goals and includes a significant portion of your savings, this transition presents a great opportunity to evaluate all your options to ensure you’re set up for success. We’ll explore several important factors so you can determine the best move for you.

Expanded investment choices

Your old employer’s 401(k) plan is managed by a plan administrator that determines what funds you’ll have access to in the account. The portfolio menu will vary substantially from plan-to-plan and can have meaningful limitations in terms of diversification, fees, and risk preferences. By choosing to move your money to an IRA, you’ll have the option to select a provider that allows you to invest in a much broader universe of funds and portfolios that may better align to your goals.  

Lower fees

Optimizing the amount you pay in portfolio fees is one of the major areas you have influence over when saving for retirement. 401(k) fees can range between 0.37% to 1.42% or more annually depending on your plan. IRA account fees have the potential to be much lower on an annual basis. While the fee percentage difference may seem small, this adds up over the years and can have a large impact on your portfolio value by the time you approach retirement age.

Fees are not the be all, end all, when making your retirement investment decisions. However, it’s a great starting point when evaluating your financial relationship with an institution to ensure you’re getting the best value for your money and ensuring the fee impact on your portfolio is minimized.

Consolidation

You’ll probably change jobs multiple times throughout your career. If you contribute 401(k) plans at various stops along the way, you’ll quickly accumulate additional retirement accounts that will vary in fund selection, fees, and portfolio strategy. Your old 401(k) accounts may also change plan administrators over time, further complicating the ability to track your funds down easily. Consolidating these accounts in an IRA may not only give peace of mind, it can ensure that your hard earned retirement dollars are all moving in the same direction that is optimized for your situation. 

IRA institution preference

While 401(k) plans vary in service offerings, an IRA gives you the opportunity to direct your retirement savings towards a strategy that’s best aligned for you. This includes self-directed portfolio management, working with a financial advisor to manage your funds, or selecting a robo-advisor which can be seen as a hybrid between the two. Regardless of your preference, with an IRA you’ll be able to align your retirement savings towards your personal goals and situation. Depending on how your 401(k) is set up you may lack the flexibility to tailor the account to your liking. 

Penalty free withdrawal options

In some cases, IRA’s provide more accessibility than 401(k) accounts. One example is a first time home buyer distribution. Typically you can’t withdraw funds in a 401(k) before age 59 ½ without incurring a 10% early withdrawal tax penalty unless you meet a specific set of criteria. However, with an IRA you’re able to access up to $10,000 without paying the early distribution fee. You may still owe other taxes such as ordinary income tax on the amount you withdraw. While you might still opt to use savings from non-retirement accounts to purchase a home, an IRA gives you more flexibility to withdraw for a home purchase than a 401(k) does. 

Roth conversion

Your old 401(k) plan may allow for pre-tax contributions, Roth deposits, or both. These contributions are locked into each respective tax designation once you’ve selected your preferred option. This can potentially limit your tax-planning strategy down the road as pre-tax withdrawals are taxed at retirement and Roth distributions are not. By moving the pre-tax 401(k) contributions to an IRA, you’ll have the option to convert these funds to a Roth IRA if you desire. You’ll have to pay tax when converting pre-tax dollars to a Roth since the funds haven’t been taxed yet. Still, it’s a helpful consideration to be mindful of so you can optimize your tax strategy moving forward.

Cons of rolling over a 401(k) into an IRA

Loss of 401(k) loan access

While IRAs generally give more withdrawal flexibility than 401(k) accounts, IRAs don’t offer loan provisions. 401(k) accounts do give you the option to take a loan up to $50,000 or half of your vested value, whichever is lesser. The loans must be paid back into the 401(k) over a scheduled time period and agreement as laid out in the plan. Although it’s often best to keep funds earmarked for retirement set aside to ensure you stay on track, there may be edge cases where having a loan option is helpful.

Limited creditor protection

The Employee Retirement Income Security Act (ERISA) of 1974 provides certain creditor protections for funds held in employer sponsored retirement accounts, including 401(k)s. This protection is not extended to IRA savings with the exception of bankruptcy. While this is something you hopefully won’t ever have to experience, these distinctions are important to note. 

No Penalty Free Access at Age 55

Your personal retirement timeline is a crucial goal to consider when deciding between a 401(k) and IRA. Both accounts allow you to take penalty free distributions at age 59 ½ to avoid the 10% early distribution tax. With 401(k)s you can access retirement funds even sooner without penalty thanks to the Rule of 55. If you’re laid off or retire in the calendar year you turn 55 or after, you can access your current 401(k) without the 10% early withdrawal penalty. There may be other specific rules you’ll need to follow to ensure you avoid the 10% penalty, but this presents an intriguing option to consider if your retirement timeline is before age 59 ½. IRAs have no such feature.

Lack of fiduciary responsibility 

401(k) plans have an extra layer of protection due to fiduciary responsibilities of your plan manager. This means that the management must act only in the best interests of all the participants in the plan and avoid conflicts of interest. Institutions that offer IRAs may or may not act in this capacity. If you choose to move funds to an IRA, this is an important element to be mindful of to ensure your retirement funds are looked after properly. 

Rollover process

If you decide to move your old 401(k) to an IRA, the next step is understanding the process so you can ensure a smooth transition. Transferring, or rolling over, your funds follows several steps that may vary a bit depending on each institution’s policies. We’ll walk through the rollover process together so you know what to expect.

The most seamless rollover option is a direct rollover. In this method, the proceeds are made out to the IRA for your benefit and sent directly to the institution. To get started, first confirm with your IRA provider the details necessary to move your funds over. This information may include an account number, address, and dollar amount. Next, get in touch with your former employer’s 401(k) plan administrator to provide these instructions and confirm what requirements are necessary to move your account elsewhere. You may be able to accomplish this with a simple phone call or be required to sign paperwork authorizing the transfer. Once your former employer has been properly notified of your intent, the funds will be sent directly to your IRA or to you for forwarding to your IRA provider.

Another transfer option is a 60-day rollover, which is when you request the old 401(k) proceeds be made out directly to you. Once the transfer is initiated, you have a 60 day window to deposit the funds into an IRA. Failing to do so will incur potentially hefty penalties and fees such as a 10% early withdrawal penalty (if younger than 59 ½ ) and treating the distribution as taxable income. You’ll also be subject to mandatory tax withholding of 20% as the relinquishing institution assumes you are cashing out the account. This process is also called an indirect rollover at minimum and should only be pursued if you know you’ll be able to re-deposit the fund within a 60 day window.

While you may not be feeling too eager about undertaking this task, it is becoming easier to make rollovers take place. Our mission is to help facilitate this process quickly and efficiently by providing step-by-step support to ensure your rollover is completed smoothly. 

Summary

Retirement is one of the major milestones you’ll be saving for in your lifetime. The variables of your personal situation play a major part in determining whether to keep your money at your old 401(k) or move the funds to an IRA. As a result, carefully consider the factors we’ve discussed so you can make a decision that aligns with your preferences and goals. 

For many reasons, rolling over a 401(k) into an IRA can be an attractive option as it generally gives access to more investment choices, can reduce your fees, and give you more peace of mind by having your retirement savings in one place. If your former employer’s 401(k) is low cost, aligns with your investment strategy, and you’re not concerned with losing track of the account in the future, then keeping your funds in place may be reasonable as well. Either way, once you’ve left an employer you have more control over determining how to optimize your retirement savings.

Is it best to rollover 401k to new employer?

Is it better to rollover 401k to new employer or IRA?

Is it better to roll your 401k into another 401k?

Can you roll a 401k into a new employer 401k?