According to our research at Capitalize, investors can lose out on an estimated $700,000 by forgetting about their old 401(k)s. Rolling over a 401(k) has a lot of practical advantages, so if you’re considering making the move, be sure to know exactly how you’ll benefit. Below, you’ll find some of the major advantages of completing a 401(k) rollover.
Many 401(k) plans are laden with high administrative fees that can make some of them less attractive than they could otherwise be. The way fees are presented — often in percentage terms, like “1%” — make them seem smaller than they are, but they can have the unpleasant effect of adding years onto your working life. Fees can be extremely sneaky, so you’ll need to read your company’s 401(k) plan documents carefully.
A brief example: Say you have $50,000 in your 401(k) at age 35, and the plan charges a 1% administrative fee. Also, assume you contribute 5% of your pre-tax salary to the plan, you intend to retire at age 65, and you feel confident about an 8% annual return on your investments. As opposed to a plan with no fees, you’d be left with nearly $230,000 less at retirement — all due to the hefty administrative fee.
Most 401(k) plans allow you to select your own investments within the plan, but your choices are generally limited — often between 10 and 20 funds sponsored by the 401(k) plan provider. With an IRA, you’re open to the entire investment universe consisting of stocks, bonds, ETFs, and mutual funds.
Note: this is not to say having more choices is always better. Some 401(k) plans offer low-cost, broad-market index funds, which can serve as sufficient core investment holdings for most people. A wider investment menu truly benefits those who are part of a 401(k) plan with unnecessarily expensive investment options.
As your wealth grows, you’ll quickly find that consolidation can do a lot of good for your overall financial plan. Old 401(k)s are often left and forgotten, which can lead to a less efficient financial plan overall. By rolling your 401(k) to an IRA at a provider of your choice, you’re minimizing the chance that any dollars get lost in the shuffle — something that’s prone to happen if you have accounts scattered everywhere. Simplicity within your investments also makes tax planning significantly easier, for a variety of reasons. For instance, you’ll receive far fewer tax forms, and you’ll have far less data to track. Simple investing also leads to longer holding periods, which will qualify your long-term gains for preferential tax treatment.
Choosing to roll over a 401(k) plan to an IRA is an active step; this isn’t something that will happen automatically. It also requires a fair amount of thought. For these reasons, rolling over a 401(k) gives you the chance to take control of your investments and give your entire financial picture the consideration it deserves. When you roll over your 401(k), you also have the chance to think through the underlying investments and ensure everything is allocated in your best interest.
Assuming you roll a traditional, pre-tax 401(k) into a rollover pre-tax IRA, there should be no tax consequences at all. You won’t be harmed — nor will you receive any benefit — by simply rolling money to an IRA in this context.
What you will be doing, however, is preserving the tax benefits you’ve already accumulated in your 401(k) plan.Additionally, by finding lower-cost investments in your IRA, you’re also giving yourself a chance to significantly enhance the tax-deferred growth in your account.
Don’t forget that tax-deferred 401(k)s and IRAs will both come with Required Minimum Distributions (RMDs) once you turn 72. These distributions are essentially forced withdrawals that will be taxed as income when removed from your account.
While the mechanics behind RMDs are nearly identical in both accounts, you’re likely to have a higher tax-deferred balance in a low-cost IRA than you would in a more expensive 401(k) plan (which would result in greater distribution amounts and higher taxable income down the line).
Note that if you aren’t careful, there can be a substantial tax cost to rolling over your 401(k). This is most relevant in the context of rolling a pre-tax 401(k) to a Roth IRA, a tax-exempt account. If you roll a pre-tax 401(k) plan to a Roth IRA by accident, you’ll be responsible for taxes on the entire balance rolled over!
Beyond perhaps some small administrative fees, it shouldn’t cost anything to roll over your old 401(k). Some plan providers may charge a “termination fee” or a “transfer fee”, but it should be extremely small — if a fee is charged at all.
The cost of rolling over a 401(k) to an IRA should be a very minor consideration in the ultimate decision to move the account.