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Updated on June 12, 2024
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When you leave a job, it’s important to decide what you’d like to do with the money you’ve invested in your former employer’s retirement plan ─ usually a 401(k). There are three primary options:
While it’s also possible to take the money out in a lump sum and use it now, it’s a pretty bad option: along with federal taxes and state income taxes, you’ll also be subject to early distribution penalties ─ and you’ll lose out on the compound interest your retirement income might have accrued over the years by keeping the money invested.
Although each of these solutions allows your retirement funds to keep growing — and ensures you don’t get a big tax bill — there are some serious advantages to consider in completing a 401(k) to IRA rollover.
In this article, we’ll recount 10 of them.
Below are the ten best reasons why a 401(k) rollover to an IRA might be a savvy financial move.
It may seem hard to imagine that you’d lose track of your retirement investments. But this happens far more often than you’d think ─ especially for people who change jobs frequently.
As of May 2021, approximately $1.35 trillion in assets has been left behind in an estimated 24.3 million 401(k) accounts. Even worse, leaving a 401(k) behind could cost you as much as $700,000 in forgone savings over your lifetime.
An IRA acts as single account to consolidate your workplace retirement savings every time you change jobs. Plus, it’s a relatively low-cost option: with one retirement account, you’ll avoid paying for redundant financial services and/or maintenance fees with multiple providers.
When you signed up for your old workplace plan, you probably didn’t have a choice as to your 401(k) provider. Your employer picked the plan’s administrator, and that financial institution was in charge of your account. That’s because your 401(k) is managed by your employer, which means you lose the ability to contribute when you leave your job, and it could even be transferred without your consent (if the balance is on the lower end).
Rolling your old 401(k) funds into an IRA, however, ensures that you can choose your brokerage and control where and how you invest your savings. As long as you move the money into a qualifying IRA, you won’t face early withdrawal penalties, and you’ll experience the freedom and flexibility to open your rollover IRA with the financial institution of your choosing.
Your 401(k) investment options are usually limited by your employer, and FINRA reports that most plans only offer a choice of between 8 to 12 funds to invest in. Some company plans offer the opportunity to invest in company stock, but even this isn’t always the case.
IRAs, however, allow you to unlock a nearly unlimited menu of investment options including stocks, bonds, ETFs, mutual funds, CDs, and even cryptocurrencies. You can even opt for a technology-driven robo-advisor if you want a more hands-off approach.
Investing fees can dramatically erode your returns over time, and the more fees you pay, the bigger the negative impact. Unfortunately, 2 in 3 Americans don’t know what 401(k) fees they’re paying, which can create long-term problems for aspiring retirees.
A 401(k) to IRA rollover opens the door to lower-cost investing. The median annual 401(k) fee is .85% of assets, while marketing-leading providers of automated or robo-advisor IRAs typically charge between 0.20% and 0.36% in advisory and investment fees.
Many IRA providers have even eliminated commission fees, as well as inactivity or account maintenance fees. Low-fee index fund ETFs and no-load mutual funds are also common offerings, so you may have the option to not only eliminate administrative fees but also reduce other expenses from your investment strategy Over time, this can lead to more investment growth than you would have otherwise experienced, potentially even reducing your retirement age!
If you have several retirement plans, it can be difficult to keep track of how they all fit into your financial goals. You’ll have to sign into several accounts when you rebalance your portfolio or keep tabs on your investments. More accounts also means more tax forms. Once you’ve left the workforce altogether, calculating a safe withdrawal rate and complying with Required Minimum Distribution (RMD) rules is made all the more difficult.
A 401(k) to IRA rollover enables you to reduce the number of retirement investment accounts you have, thereby simplifying and streamlining your total financial picture.
When it comes to retirement planning, it’s crucial to have the right asset allocation.
Unfortunately, having multiple retirement plans can make it harder to get a big picture view of your portfolio to ensure your money is invested appropriately — even if you’re working with a financial advisor.
If you’ve completed a 401(k) to IRA rollover and consolidated your investments into one new IRA account, you can see at a glance where all your money is. This reduces the chances you’ll concentrate your portfolio too heavily in one particular industry or that you’ll have too much or too little risk exposure to a certain asset class, making it easier to tailor your investment management towards your financial goals. This can also make it easier to get investment advice from a Certified Financial Planner if you have one.
If your previous employer is managing your retirement account, it might not be their top priority to answer your questions or respond to requests. When choosing between IRA providers, you can prioritize ones that have robust customer service teams and a strong reputation, which can simplify the process of a direct rollover.
If you’ve left behind a tax-deferred employer-sponsored retirement plan 401(k) account (as opposed to a Roth 401(k) account), you usually need to roll over directly into a traditional IRA to avoid tax consequences and potentially a 10% early withdrawal penalty.
If you’d prefer a Roth IRA, though, you still have the option to convert your traditional IRA into one. A Roth account allows you to take tax-free withdrawals once you hit retirement age, whereas you’ll pay regular income taxes on withdrawals from traditional, pre-tax accounts.
If you expect your tax bracket to be higher later in life, taking the tax hit up front to lock in tax-free and penalty-free withdrawals later (with a Roth IRA) may be a worthy consideration. You might also have an opportunity to convert pre-tax IRA funds to Roth in a lower-than-expected income year to minimize tax implications.
Finally, you may have an opportunity for a Roth conversion if your 401(k) account balance has temporarily fallen — like during a market correction.
IRA providers want to earn your business, and to do that, some might offer a financial incentive or other types of benefits to open an account with them.
For example, you might be offered $100 for moving over an retirement fund account with a balance of up to $50,000 or may be offered as much as $1,000 by investing at least $500,000 in funds in your new rollover IRA.
Given the numerous other benefits of 401(k) rollovers, this one feels like icing on the cake.
Finally, while IRA rules are standard across firms, and you can review IRS information to learn your rights and obligations, 401(k) rules often vary from one employer to another. The specifics may depend on the policies in place and your employer-sponsored retirement plan administrator.
If you want to easily understand how your account works, as well as seamlessly learn the rules for investing and withdrawing funds, an IRA can be a better account choice than a 401(k).
Remember, cashing out an old 401(k) early can be a costly mistake resulting in early withdrawal penalties and additional taxes. Leaving your savings behind can make your investment management more complicated. If rolling over your 401(k) into an IRA is the right choice for you, Capitalize can make this process simple. From filling out forms to following up with your 401(k) provider, our team does it all. We’ll even send you a prepaid, pre-addressed envelope to mail your rollover check and keep the ball rolling.
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