Rolling over vs. retaining an employer retirement plan
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 67% 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 on to—you have 4 options:
- Roll over to your new employer's plan. If you're moving to a new job that offers a retirement plan and allows you to roll in existing assets, it's worth getting the details before you decide—you may find extremely low fees or attractive investment options.
- Roll over to an IRA. This option lets you preserve the tax advantages of your old plan and access a wide range of investment options. Plus, many people find that combining their retirement savings accounts into one place makes it easier to manage their money and track their progress.
- Cash out. There could be significant drawbacks with this option, so before cashing out, ask yourself whether you urgently need the money. You'll likely owe income tax on the money you withdraw and, if you're under 59½, you could be subject to a 10% early withdrawal penalty from the IRS.
Note: The 10% penalty won't apply if you've left your job at age 55 or older (age 50 in some public service jobs).
- Leave your plan in place. If you're not ready to make the decision, staying put is an option. You can always choose to roll over into an IRA or another employer plan later. Just be aware of any possible restrictions or downsides to retaining your 401(k) plan. How much access to the plan administrator will you have as a nonemployee? Are there maintenance fees involved? You won't pay taxes on the 401(k) while it remains invested, but as a former employee, you can no longer make contributions to the plan. And if your balance is under $5,000, your employer can distribute it without your consent, so you'll want to have a plan in place.
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, or 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).
Investment options and flexibility
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 [exchange-traded funds] and mutual funds from which to choose" That's in addition to individual stocks, CDs (certificates of deposit), 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.
Could you benefit from advice?
The best path forward for you will depend on several factors. Having a trusted advisor to talk through your options can bring clarity 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).
If not, a qualified financial advisor or robo-advisor can provide ongoing guidance and help keep your investments on track.
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 contributions 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 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.
What's your motivation?
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 73.* For each 401(k) account you hold, you'll need to calculate and withdraw your 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 73 (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 start taking RMDs at 73, even if you're still working, but you can choose to take them from any or all your traditional IRAs.
If you have Roth money in your 401(k), keep in mind those accounts are subject to RMDs in 2023, whereas Roth IRAs are not. Starting in 2024, RMDs won't be required from Roth in your 401(k). You still may consider moving any Roth money out of your 401(k) and into a Roth IRA.
Lobel's overall advice is to ask yourself what your driving motivation is. "Are you trying to simplify your financial life—consolidate 5 plans into 1—to make things more manageable? Or are you OK having more than 1 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.
Roll over to a Vanguard IRA
*Due to changes to federal law that took effect on January 1, 2023, the age at which you must begin taking RMDs differs depending on when you were born. If you reached age 72 on or before December 31, 2022, you were already required to take your RMD and must continue satisfying that requirement. However, if you had not yet reached age 72 by December 31, 2022, you must take your first RMD from your traditional IRA by April 1 of the year after you reached age 73.
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.
Vanguard's advice services are provided by Vanguard Advisers, Inc. ("VAI"), a registered investment advisor, or by Vanguard National Trust Company ("VNTC"), a federally chartered, limited-purpose trust company.
The services provided to clients will vary based upon the service selected, including management, fees, eligibility, and access to an advisor. Find VAI's Form CRS and each program's advisory brochure here for an overview.
VAI and VNTC are subsidiaries of The Vanguard Group, Inc., and affiliates of Vanguard Marketing Corporation. Neither VAI, VNTC, nor its affiliates guarantee profits or protection from losses.