When you’ve switched jobs multiple times in your career, you may have participated in several employer-sponsored retirement plans, such as 401(k) and 403(b) plans. 401(k)s are generally provided by many for-profit employers, while 403(b) plans are most often used by the nonprofit sector.
What many people don’t know is that when you leave a job, it’s important to consider carefully what you do next with your employer-sponsored plan. While working, one of the best ways to save for retirement is to fund an employer-offered plan because they often have important tax advantages and higher contribution limits than individual retirement accounts. But after you leave a job, there are several important reasons to consider rolling over funds from your 401(k) or 403(b).
In this article, we’ll run through some of those reasons.
1. Accessing more investment options
One of the main benefits of an IRA is that there are often more investing options than a 401(k) or 403(b) plan. If you contribute to your employer’s retirement plan, you might end up with only a few options chosen by the plan administrator. You might have to be heavily invested in company stock or you might have a limited number of high cost mutual funds to choose from. We don’t bring this up as a way of lambasting your administrator—they’re simply trying to pick the options they believe should be made available to all employees—but many people don’t realize just how limiting these options can be.
If you have an account with a previous employer, you may not have any worthwhile reasons to stay with the limited investment choices within the plan, and that’s one reason to consider rolling into an IRA. An IRA held at a brokerage or investment advisor, like Betterment, enables you to access a much broader universe of funds.
For some investors, having the ability to pick and choose any variety of funds is important to them. At Betterment, our investment advice for an IRA (and any account type) is based on research-backed portfolio construction that pursues a highest expected return for the risk you’re willing to take on, while maintaining global diversification and low costs.
2. Lowering Your Investment Fees
The fees with an IRA can sometimes be lower than what is charged by your plan administrator. In many 401(k) and 403(b) plans, the expense ratios (i.e. fees) on mutual funds and ETFs can be much higher than those available within IRAs. Also, depending on your plan, by keeping funds within your 401(k) plan after leaving your employer, you may be subject to management fees.
Moving to an IRA may involve taking on fees for investment advice and management or trading costs, but all-in, when you do the cost analysis, an IRA can often be less expensive than a 401(k) plan. When evaluating fees, do keep in mind, that if your current employer-sponsored plan is among the nation’s top plans, it could also be worth your while to hold your funds there.
3. Managing Your Portfolio in One Place
For many investors, part of the value of rolling over to an IRA comes from the peace of mind of having all of their past retirement contributions (and other investments) in one place, rather than spread out across multiple old employer-sponsored plans and investment providers. When you understand the full picture of your retirement savings, you can often make better estimates of what your future retirement budget could look like.
Furthermore, depending on your situation, if you move your retirement assets to one provider, you can also improve the tax-efficiency of your taxable investments using asset location. You can learn more about how Betterment’s Tax Coordination of IRAs and taxable accounts helps increase potential after-tax returns here.
Roll over correctly, and you probably won’t need to worry about taxes.
Even with the above benefits of rolling over, many people hesitate on the fear of causing themselves extra taxes. The good news is that when rolling over a 401(k)/403(b) or any other employer sponsored plan, we use the direct rollover method to prevent any withholding or negative tax consequences.
There are two important things to remember in regards to taxes when rolling over:
- Be sure to designate a withdrawal from your current provider as a rollover.
- A rollover from a traditional 401(k) or 403(b) should enter a traditional IRA. A rollover from a Roth 401(k) or 403(b), should end up in a Roth IRA.
If you withdraw from a traditional 401(k) or 403(b) as a non-rollover before age 59 ½, you will face a 10% penalty for an early withdrawal. If you rollover from a traditional plan into a Roth IRA, you will have to pay income taxes on the money. Both of these situations are unnecessary for most investors, except in certain circumstances.
The key is that when deciding whether to rollover a retirement account, you should carefully consider your personal situation and preferences. In this article, we’ve provided three general reasons to consider rolling over to an IRA, but as an individual investor, your situation is unique. This article is not an individualized recommendation that you take any particular action—just useful information for you to think about.
As suggested above, there are a variety of factors to consider when evaluating the choice to make a rollover. In addition to the points above, you might want to consider::
- The investment options you have access to
- The current and future fees and expenses you face
- The investment services you need (and could gain or lose)
- Any penalties you could face when withdrawing your money
- Protections from creditors and legal judgments
- Required minimum distributions associated with certain accounts
- The treatment of employer stock within your employer plan
The world of retirement planning is complicated, no doubt about that. So, before deciding to roll over an employer-sponsored plan, you should research the details of your current account and consult tax professionals and other advisors with any questions about your specific personal situation. If you’re a Betterment customer, you can ask questions of our licensed financial experts using the Betterment mobile app.