I’ve switched jobs several times in my career, and each time I had to decide what I wanted to do with my 401k. Each time, I rolled it over into a traditional IRA—and not because my employer’s 401k was bad (usually it was average), it was that there were so many benefits to rolling over to an IRA in an actual brokerage firm.
One of the best ways to save for retirement is to use a tax-advantaged plan offered by your employer, such as a 401k and 403b. You can grow your wealth through the help of investing, and more of your money can grow, thanks to the tax advantages. The tricky part is always whether you have enough options. Not all defined contribution plans, as these are known, are created equal and sometimes the fund options in the company plan—or the plan fee—make it a dicey proposition at best.
But when you leave a company, you have the option of rolling over your account into an IRA, keeping it with your provider, or rolling it over to your new employer’s plan. I’ve always opted to rollover my plans into a rollover IRA and here’s why.
More investing options
One of the main benefits of an IRA is that there are often more investing options. 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. The point isn’t to lambaste the administrator, they’re simply trying to pick the options they believe should be made available to all employees.
Instead of relying on these investment options, some of which you might not be comfortable with, you can roll your plan over to an IRA and have nearly the entire universe of options available to you. IRAs are individual accounts so you have access to a wider variety of investing options. You might be able to add cash, bonds, and stocks, as well as other asset classes, to your IRA.
The fees with an IRA can often be lower than what is charged by your plan administrator. I know that when I rolled over my 401k, the brokerage charged no annual administrative fee and that saved me $50 a year. The only fees I paid were the expenses of the mutual funds I was invested in, which my 401(k) was also charging me. Lastly, the expense fees I was paying now were much lower because they were index funds rather than actively managed funds. You can’t control how your investments perform but you can control how much you pay in fees, which has a direct impact on your returns.
What about taxes?
If you roll over to an IRA, you don’t normally need to pay taxes. As long as you are careful to designate your withdrawal as a rollover, and as long as the money is invested in a Traditional IRA, you don’t have to worry about taxes. The only exception is if you are rolling your money over from a tax-deferred account into a Roth IRA, which is known as a conversion.
With a tax-deferred account, such as a traditional 401(k) or 403(b), you receive a tax deduction and you are expected to pay taxes later, when you withdraw from your account. If you roll over the money from a traditional plan to a Roth IRA, you will have to pay income taxes on the money (although you will escape the 10% penalty for an early withdrawal if you are under 59 ½ years of age).
Carefully consider your financial situation. It may be that it makes sense for you to roll your 401k or 403b into an IRA to improve your investment options, or to better handle your tax planning for the long run.