Should you choose a rollover IRA or hang on to your employer’s retirement plan? In this article, we’ll walk you through key considerations to help you make a smart choice.
The average worker in the U.S. today will hold 10 different jobs before the age of 40, according to the Bureau of Labor Statistics. And that figure is expected to grow in the years ahead. If you’re among the 64% of Americans with access to a defined contribution retirement plan—commonly known by its IRS designation as a 401(k), or in some cases a 403(b) or 457(b)—through your employer, this means you’ll likely face this decision several times throughout your life: What should I do with my existing plan?
When you’re leaving a job with a retirement plan—or considering what to do with an older account you’ve held onto—you have 4 options:
Choosing a rollover IRA can potentially bring you many benefits: reduced costs, consolidation, a wider range of investment options, and tax advantages. But you should keep some particulars in mind as you weigh the decision.
Make sure you understand the fees you’re paying on your 401(k). Many people don’t consider this when they first enroll. But now’s the time to dig in and find out if your money could be working harder for you. Talk to your plan administrator, or review the plan documents, and make sure you’re looking at overall fees—including administrative and investment fees—when you compare your options.
“If your plan was great and its fees are rock bottom, then maybe you would choose to stay,” says Vanguard Senior Investment Analyst Hank Lobel. But it’s better to base your decision on information rather than inertia.
A difference of, say, half a percentage point, even 1%, may seem insignificant. But over the years that difference can add up to tens of thousands of dollars in potential savings growth. As an individual investor with an IRA, you’ll pay fund fees and transaction fees, but if you shop around, you can likely find an option with lower overall costs than your 401(k).
Most 401(k)s offer a relatively limited menu of core options. The investment options are determined by your employer and the type of plan it offers. If your plan includes a specific investment that isn’t available through an IRA and is integral to your investment strategy, that may be a reason for you to stay put.
By contrast, when you open an IRA, the investment options are practically unlimited.
“With an IRA, the world is your oyster,” says Lobel. “There are thousands of low-cost ETFs and mutual funds from which to choose.” That’s in addition to individual stocks, CDs, and other investment vehicles.
Lobel cautions that “for some people, more choice can be overwhelming.” But with a bit of research, you can find the right investments to match your goals and give you the diversification that’s key to investment success.
The best path forward for you will depend on several factors. Having a trusted advisor to talk through your options can bring clarity to your process and help you feel confident in your decisions. Some employer-based plans provide access to advice and even cover the advisory fees. If that’s the case, you may want to hold on to that benefit and retain some or all your funds in the 401(k).
Note: An advisor can help with IRAs but might have limited access to your 401(k) plan. “If you’re going to hire someone,” Lobel says, “find out whether they can offer advice on your plan.” It may not be a deal breaker, depending on your situation, but you’ll certainly want to know before you decide.
The great advantage of traditional 401(k)s and IRAs is the ability to defer taxes until you reach retirement. When you roll from a 401(k) plan to a rollover IRA, you maintain that benefit and keep saving for the future while your money continues to grow tax-deferred.
You can also roll your 401(k) into a Roth IRA, if you’re looking for more flexibility, but be aware you’ll have to pay taxes upfront if you do. (With a Roth IRA, you pay taxes on your initial contributions but not at the time you withdraw.) If you already have Roth accounts within your 401(k) plan, you’ll need to roll those into a Roth IRA, but you won’t have to pay taxes.
Pro tip: If you’ve made after-tax contributions to your 401(k), there’s a distinct advantage to rolling those funds over to IRAs. Your after-tax contributions would roll to a Roth IRA—as of now, although proposed policy changes could remove this option in the future— and your tax-deferred earnings would roll to a traditional IRA. Rolling after-tax contributions to a Roth IRA unlocks the advantage of tax-free growth on those assets, instead of deferring the taxes if you were to leave your old 401(k) plan in place or roll your investments into a new employer plan.
For many people, gaining clarity is the overriding factor in choosing a rollover IRA. Keeping track of multiple employer accounts and making sure they’re rebalanced appropriately can get complicated. Putting all your retirement savings in one place makes it easier to manage your accounts and monitor your progress.
This can be especially true as you near retirement and the onset of required minimum distributions (RMDs), which kick in at age 72. For each 401(k) account you hold, you’ll need to calculate and withdraw the RMD separately. However, if you’re still working, you won’t need to take RMDs from your employer’s plan.
Pro tip: If you’re planning to work past age 72 (and you don’t own 5% or more of your company), you may want to consolidate accounts into your current employer retirement plan and avoid RMDs until you officially retire.
With an IRA, you’ll need to take RMDs at 72, even if you’re still working, but you can choose to take them from any or all your traditional IRAs.
If you have a Roth in your 401(k), keep in mind those accounts are subject to RMDs, whereas Roth IRAs are not. You may want to move any Roth account out of your 401(k) and into a Roth IRA.
Lobel’s overall advice is to ask yourself, what’s the driving motivation for you? “Are you trying to clear up your financial life—consolidate 5 plans into 1—to make things more manageable? Or are you OK having more than one plan?”
If you still have questions, talking with a qualified financial advisor can help you understand your options and make the best choice. Whatever you decide, you’ll feel better knowing you’ve done your homework.
All investing is subject to risk, including the possible loss of the money you invest.
Diversification does not ensure a profit or protect against a loss.
There are important factors to consider when rolling over assets to an IRA or an employer retirement plan account, or leaving assets in an employer retirement plan account. These factors include, but are not limited to, investment options in each type of account, fees and expenses, available services, potential withdrawal penalties, protection from creditors and legal judgments, required minimum distributions, and tax consequences of rolling over employer stock to an IRA.
We recommend that you consult a tax or financial advisor about your individual situation.
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