Should I roll my funds into my 401(k) or IRA account at Betterment?

If your employer offers a 401(k) through Betterment that permits rollovers into the plan, you have the option to roll your old 401(k) into your new 401(k), or roll it into an IRA. The right decision for you depends on many different factors.

This is a general, educational guide that defines the major differences between a Betterment 401(k) and Betterment IRA. It is not a comprehensive list, nor is it a recommendation as to what any particular Betterment customer should do. Some of these factors may be of importance to you, while others may not apply at all. After reading this guide, if you’re still unsure what to do, we encourage you to speak with a financial advisor about your specific needs.

Ownership

IRAs are individually-owned retirement accounts that anyone can open to roll retirement funds into. A 401(k) account is slightly different. 401(k)s are offered through your employer, and the funds inside the account are actually part of a trust that is managed for you and all other employees. This difference in ownership is a key distinction. You and only you own your IRA, and thus you generally have greater control and flexibility. You do not own your 401(k) outright, and thus generally have less control but greater protection. We will explore specific examples of these tradeoffs in greater detail below.

Fees

Betterment’s IRAs and 401(k)s have different fees attached to them. A Betterment IRA will be subject to an advisory fee of 0.25% - 0.40% per year. This is the only fee you will pay Betterment. There are never any trading costs or fees to deposit/withdraw money. Read more here.

401(k) accounts have greater regulatory and filing costs associated with them, which typically translates into higher overall fees, both to Betterment and to any additional service providers hired by your company. However, your employer may pay some or all of those fees on your behalf, potentially making your own fees cheaper than an IRA. You should analyze your fees to determine whether rolling money into your Betterment 401(k) or IRA would be more cost effective. Please contact us if you’re unsure of what your fees are.

While fund costs are generally an important part of assessing your total fees, the portfolios in the Betterment 401(k) and Betterment IRAs are exactly the same, and fund costs are thus not discussed in this section.

Required Minimum Distributions (RMDs)

Both IRAs and 401(k)s force you to begin withdrawing money once you reach age 72. Most of the time this money is from pre-tax contributions, meaning that every dollar you withdraw for your RMDs will be taxable as ordinary income.

However, if you are still working at age 72 you may be allowed to delay your 401(k) RMDs until the year in which you retire. This can be helpful if you plan to work well into your 70’s and thus will not need the RMD income to support your lifestyle. Allowing that money to stay invested and grow tax-deferred can be a significant benefit.

IRAs have no such exception to RMDs. Even if you are still working, you must take your RMD from any money you have in an IRA. Also note that while Roth IRAs do not have RMDs, Roth 401(k)s do.

Accessibility

Both IRAs and 401(k)s are retirement accounts, and per IRS rules, generally can only be accessed after age 59 ½. However, there are exceptions to this rule, and these vary between IRAs and 401(k)s. If you may need access to your funds before 59 ½, these exceptions can be an important factor in determining which account to roll your money into.

We strongly encourage you to carefully review the differences between the exceptions for both accounts, but we’ll explore some of the more important details below.

With Betterment IRAs, you can always withdraw your funds without any fees. However, doing so before age 59 ½ may lead to taxes, as well as a 10% penalty. Learn more about exceptions to the 10% penalty on early IRA withdrawals. Some common examples include qualified education/medical expenses, qualified first-time home purchase, or if you become disabled.

401(k) plans have a different set of rules. You generally cannot make withdrawals from your Betterment 401(k) while you are still working at the company that sponsored the 401(k). An exception to this rule is if you are still working but have reached age 59 ½. This is called an in-service distribution and will be subject to a $75 fee per distribution payment.

One benefit to a 401(k) is that it may allow you to begin withdrawing money penalty-free if you leave your job at age 55. This is almost 5 years earlier than if that money was in an IRA.

Some 401(k) plans allow you to take loans and borrow against your own assets. IRAs do not allow loans under any circumstances. 401(k) accounts can also offer “hardship distributions”, where you are permitted to take a withdrawal under specific circumstances (as defined by the IRS) even while employed, though the distribution may still be subject to a 10% penalty if you are under age 59 ½. Both loans and hardship distributions from a Betterment 401(k) are subject to approval by your employer, and will be subject to a $75 fee per distribution payment. Please contact us if you’re unsure whether your Betterment 401(k) offers loans or hardship distributions.

Roth Conversions

If you plan on converting non-deductible Traditional IRA to a Roth (sometimes referred to as a “backdoor Roth contribution”), you may want to consider rolling into your 401(k) and not your IRA because of the IRS pro-rata rule. See an example of this rule. Putting the pre-tax funds into your Betterment IRA will reduce the effectiveness of the backdoor Roth and may lead to more taxes.

However, if you plan on converting your pre-tax 401(k) contributions after you roll them over,. you should know that Betterment 401(k) plans do not allow you to convert your Traditional funds into Roth funds at this time. Betterment IRA accounts do allow you to easily complete a conversion directly on the website.

Employer Stock in Your 401(k)

If you hold stock of the company you work for in your 401(k), you may be eligible for a strategy called Net Unrealized Appreciation (NUA). The purpose is to save you money on taxes.

Essentially, the strategy involves moving the employer stock to a taxable investment account. When you do this, you generally pay ordinary income taxes up to the cost basis of the stock, which you would pay anyways when you withdrew the money from your 401(k). However, all future growth will be taxed at the lower long term capital gains rates. If instead you immediately roll all the money into an IRA, you lose the chance to do the NUA strategy which could save you considerable money in taxes. Any remaining money that was not invested in employer stock can be rolled into a 401(k) or IRA. This is a complex strategy and requires a thorough analysis of your tax situation and risk tolerance. We recommend speaking with a tax professional if you are considering this strategy.

Distributions from Roth IRAs and 401(k)s

For both Roth 401(k)s and Roth IRAs, you’ll need to reach age 59 ½ and generally have owned the account for at least five years before you can take distributions tax and penalty free. If you are under age 59 ½ or started contributing less than five years ago, there are important differences to consider in the distribution rules for IRAs and 401(k)s.

Roth IRA contributions can still generally be withdrawn first without any penalty or any taxes owed. In contrast, Roth 401(k) withdrawals follow a less favorable pro-rata rule. Any Roth 401(k) distribution must be a mixture of both post-tax contributions and pre-tax earnings, relative to the total balance of each in your account, so you may owe taxes and a 10% penalty on the earnings portion.

Additionally, rolling your Roth funds between retirement plans may extend or restart the five year clock, based on the type of accounts between which you are moving. This may impact the taxation of your withdrawal of your earnings, even if you are over the age of 59 ½. Read a more detailed analysis of the various five year rules.

Finally, please note that the IRS does not allow you to roll a Roth IRA into a Roth 401(k). Only Roth 401(k)s can be rolled into your Betterment Roth 401(k).

Lawsuit and Bankruptcy Protection

In general, federal law governs employer sponsored plans while state law governs IRA accounts. Protection for the accounts can vary based on the state that you live in, so if these issues are a concern for you, we recommend speaking with a trusted legal advisor.

Services

If you have a 401(k), you may receive advisory and financial services from your former employer or from a third-party service provider. These services may include workshops, educational materials and even individual financial planning. If you do receive such services, they may no longer be available to you if you roll over your 401(k) to an IRA. Betterment generally offers the same advisory services to 401(k) and IRA customers, and this is discussed in further detail below, under the “Similarities” section.

Similarities

Whether you choose an IRA or 401(k) within Betterment, you’ll get the same easy-to-use website and advice features. Not only do we use the same low cost, passive index funds in both accounts, but we also provide customized advice about your asset allocation and whether you’re on track for retirement. We also offer a wealth of knowledge in our Resource Center.

Rollovers don’t count towards your contribution limit, so while IRAs and 401(k)s have vastly different limits, you don’t have to consider them here. Both accounts allow you to enter in beneficiaries easily on our website, and finally, both accounts preserve the tax-advantaged nature of your funds.