401(k) vs. IRA Rollovers: Which One Should You Choose?

If you’ve ever worked for a private company that offers retirement benefits, there’s a good chance you’ve had access to a 401(k) plan. 401(k)s are employer-sponsored retirement plans that allow you to build your retirement savings in a tax-advantaged way. Each employer’s plan will vary in terms of investment choices and other factors, but the plans tend to function in basically the same way.

An IRA account is an Individual Retirement Account that helps you save for retirement while also displaying some similar tax advantages to a 401(k). Unlike a 401(k), you can open an IRA on your own — you don’t need any association with a job or company. This makes it especially useful for self-employed individuals or contract workers.

So what happens if you have a 401(k) and change jobs?

When managing a retirement account from your former employer, you have a few choices. This article will discuss 401(k) and IRAs as rollover options, the steps required to transfer your accounts, and how to choose the best option for you.

Reasons to Roll Over an IRA into a 401(k)

As we mentioned, a 401(k) is a retirement account sponsored by your employer, where you can contribute in a tax-advantaged way. 401(k)s also often come with employer matching contributions, which allow you to grow your retirement savings faster. Like traditional IRAs and Roth IRAs, there are two types of 401(k)s:

• With a traditional 401(k), you make pre-tax contributions, which reduces your taxable income when you file federal taxes. The tradeoff is that you’ll have to pay taxes on any amounts withdrawn, which generally happens in retirement.
• When you have a Roth 401(k), you pay taxes first and then make your contributions, allowing you to take qualified tax-free distributions in your retirement years.

If you currently have a traditional IRA and have a job with a 401(k), there are some benefits to rolling over your IRA into your 401(k):

Simplify your retirement planning

Having multiple accounts and plans can become difficult to manage, particularly as the account balances get larger. Many investors find it easier to manage their money when their funds are centralized or in one location. Rolling over your IRA into your 401(k) can help you reduce complexity and make it a bit easier to manage your money.

Potential for lower fees

Many people are told that 401(k)s have higher fees than typical IRA retirement plans. Although this is usually true, there are some exceptions to the rule that may make it worthwhile to complete a rollover into your 401(k). For example, if you work at a large company with a high-quality 401(k) plan, you may see even lower fees than your IRA.

Access to suitable investment options

Some large companies have 401(k) plans that allow you to access high-performing, low-cost mutual funds as well as efficient target date funds. Certain plans even provide personalized financial advice for free. If this is the case, you might consider rolling over your IRA into your 401(k) to maximize these benefits at a minimal cost.

Higher 401(k) contribution limits

The IRS outlines the contribution limits for retirement accounts, and they can change from year to year. But a 401(k) will allow you to make a larger contribution each year than will an IRA.

For 2023, the 401(k) employee contribution limit is $22,500 ($30,000 if you’re over 50). For an IRA, it’s $6,500 if you’re under 50 ($7,500 if you’re over 50). Maxing out your 401(k) can also help you meaningfully reduce your tax bill in the current year, which makes sense especially if you’re a high earner.

It’s also important to know that you can contribute to both a 401(k) and an IRA in the same tax year without contributions to one plan affecting the contribution limits for the other.

Ability to take out 401(k) loans

Although most financial advisors will suggest you avoid 401(k) loans, you can borrow from your 401(k) as a last resort. IRAs don’t come with loan options, so rolling over your IRA into your 401(k) might make your funds more available in an emergency.

Access your money at a younger age

With a 401(k), under the Rule of 55, you can access your 401(k) money early and without penalty. If you’ve separated from your employer and have turned age 55, you can access your 401(k) money without incurring an early withdrawal penalty.

With an IRA, you have to wait until you’re 59 1/2 to take money out without a penalty — unless you fall into an IRS exception category. Moving your money into a 401(k) could help you access funds earlier and without any need to claim an exception.

Reasons you might not want to combine your IRA with your 401(k)

As with any financial decision, there are pros and cons. Despite the reasons given above, there are also reasons why keeping your IRA separate may be beneficial. From several angles, IRA accounts have advantages over 401(k)s, which is why so many people choose to roll their 401(k)s into IRAs.

More investment options

A 401(k) account is offered by a plan administrator who provides a limited pool of mutual funds for you to choose from. With an IRA, on the other hand, you can invest in almost anything. Using either a financial advisor, a robo-advisor, or your own investment management expertise, you can choose your portfolio to match your specific needs, priorities, and goals.

Added opportunities for early withdrawals

Although you can’t take a loan from your IRA like you can with a 401(k), there are some cases where you can take an early distribution from your IRA without penalties — these include things like higher education expenses or a down payment for a first home. There are limits on these amounts, and you will still owe income taxes on the withdrawals.

Better for managing investments on a budget

IRAs can be a low-cost option for retirement savings, especially when compared to some legacy 401(k) plans. Even if you don’t want to pick your own investments, you can easily find a robo-advisor that offers much lower fees than most 401(k) plan providers.

How Do I Transfer a Traditional IRA into a 401(k)?

If you’ve conducted all your research, spoken to a financial advisor or a tax advisor, and decided to roll over your IRA into a 401(k), follow these steps to complete the transfer.

Remember that you can also roll over your previous employer’s 401(k) into your new employer’s plan (your new 401(k)) by contacting your old employer or account administrator.

Step 1: Confirm your eligibility

The IRS outlines the type of accounts that can be transferred to one another in their rollover chart.

For example, a traditional IRA can’t be rolled over to a Roth 401(k) because of differences in tax treatment between the two accounts. Ensure your IRA assets and employer-sponsored retirement plan are compatible for rollover before you start.

Also, confirm with your current 401(k) plan provider that they’ll accept IRA roll-ins. Most plans will accept them, but it’s always smart to check ahead of time.

Step 2: Check your 401(k) plan investment options

Explore the mutual funds (and other investments) available in your 401(k) plan to ensure that you’re satisfied with your investment options.

Step 3: Contact your 401(k) and IRA providers

Get in touch with your 401(k) plan administrator to discuss rolling over your IRA, and do the same with your IRA provider. Make sure that both parties are on the same page with regard to your rollover. They’ll set you up with any forms you need to fill out — but be ready to provide information to either side if requested.

Step 4: Complete the necessary paperwork

Complete all forms with your 401(k) and IRA providers to initiate a direct rollover between the two accounts.

With a direct rollover, one brokerage moves the funds directly to your new account at the other financial institution. These rollovers tend to make sense since the money never enters your hands; this is an easy way to avoid taxes and fees.

Pros and Cons of Rolling Over a 401(k) to an IRA

We’ve already covered why you may or may not want to roll over your IRA into your 401(k) account, but what about the reverse scenario? There are a ton of reasons why you might consider rolling over your 401(k) into your IRA.

Let’s explore how and when this might be a good idea.

Advantages of rolling over a 401(k) to an IRA

• More investment options: A 401(k) usually offers a limited pool of mutual funds to invest in, whereas an IRA has almost an infinite selection of stocks, bonds, ETFs, and other asset classes for you to choose from.
• More control over investments: Your 401(k) is managed by your employer’s plan administrator, but with an IRA, you can manage your own investments, work with a robo-advisor, or find your own financial advisor to help. In short, there’s a lot more flexibility around investment management with an IRA.
• Potential for lower fees: Your 401(k) plan may have higher fees because of the financial institution or plan administrator overseeing the account. With a self-directed or robo-advisor IRA, you can save on account fees since IRAs tend to have more competitive pricing.
• Greater flexibility for withdrawals: With IRAs, there are options for penalty-free withdrawals in specified situations, like if you need money for higher education costs and/or a first-time home purchase. Note that these withdrawals, if coming from a pre-tax IRA, will still be taxable.
• No taxes or penalties on rollovers: If you roll over your pre-tax 401(k) to a traditional IRA, you shouldn’t have to pay any taxes or penalties — especially if the rollover is done as a direct transfer and the money never enters your hands as an individual.

Disadvantages of rolling over a 401(k) to an IRA

• Potential for higher fees: While it’s normal for an IRA to have lower fees than a 401(k), you may have a low-cost 401(k) if you’re working for a larger company with a lot of participants. It’s worth comparing the two before assuming one is more expensive than the other.
• Less creditor protection: When you leave funds in a 401(k), you lock in maximum creditor protection should you ever find yourself in bankruptcy court. These protections vary state-by-state with IRAs.
• Less flexibility with loans: Most 401(k) plans offer the option to take a loan against your plan balance, while IRAs don’t. With an IRA, there’s always the option to take a penalty-free withdrawal for certain reasons, but there is no loan provision.
• Tax rules on withdrawals: If your 401(k) is invested in company stock, you may have helpful tax advantages when it comes to future withdrawals. You won’t see them from an IRA.

Popular FAQs

Is it better to roll over your 401k to an IRA?

The answer is completely subjective and depends on your particular circumstances. If you have a traditional 401(k), you can complete a direct rollover to a traditional IRA while avoiding taxes and continuing to grow your retirement saving in a tax-deferred fashion.

For many people, there are benefits to rolling over their 401(k) to an IRA. Whether it’s the right move for you depends on the totality of your financial situation.

Consider speaking with a financial advisor to find out which option is best.

What is the best choice for an IRA?

There are several types of IRAs, including SEP IRAs, traditional IRAs, Roth IRAs, and SIMPLE IRAs.

Many retirement experts recommend the Roth IRA to individuals who want to avoid Required Minimum Distributions (RMDs) in the future or want to pay taxes today in exchange for a zero tax bill in the future.

A Roth IRA is not the best option for every investor, as so may be better off with a traditional IRA. Traditional IRAs tend to work best for those not covered by a retirement plan at work, or for higher-than-average earners. It really varies from person to person.

What are the tax implications of rolling over a 401(k) to an IRA?

If you complete a direct 401(k) rollover correctly, you shouldn’t have any tax consequences from rolling over your 401(k) to an IRA of the same tax treatment.

If you attempt an indirect rollover, you leave open the possibility for income tax and an early withdrawal tax penalty if you don’t adhere to the 60-day rule. Needless to say, only attempt an indirect rollover if you are confident you can complete it in a timely fashion.

Need Help Rolling Over a 401(k) into an IRA?

Rolling over your IRA to a 401(k) can help you simplify your planning. It can also provide access to professional financial advice through your plan administrator. Rolling over a 401(k) to a rollover IRA can also be a smart move, especially if you want access to a wider selection of investments or if you’ve found a lower-cost retirement plan.

But managing a rollover when you change jobs or prepare to retire can be challenging.

For a large share of people, it’s best to work with a trusted partner to ensure your rollover gets done right.

Capitalize can help you make the rollover process stress-free and simple. We can help you find your old 401(k) accounts, and help you consolidate them with your other retirement savings plans.

Explore how we can help you streamline your finances by locating your old 401(k)s once and for all.