Whether switching jobs or retiring, one question you’ll likely ask is: What should I do with my old 401(k)?
This question is on the minds of more people than ever. Millions of baby boomers retire each year while millennial workers change jobs more frequently than their predecessors.
There are four things you can do with a former employer’s retirement account. You can keep it, transfer it to your new employer's plan (if allowed), or withdraw the entire balance in cash. The fourth option is an IRA rollover, which is the transfer of funds from your retirement account into a Traditional IRA or Roth IRA.
Depending on your financial needs, rolling over an old 401(k) or other type of retirement account into an IRA may make sense for you. Here are some of the potential benefits of an IRA rollover:
1. Greater flexibility and choices
Generally, an IRA allows you to select from a much larger number of investments than an employer-sponsored retirement account. The typical 401(k) offers 25 investment options, according to research by the Investment Company Institute and BrightScope. Meanwhile, with an IRA you essentially have the freedom to invest in most publicly available investments.
More investment options give you a greater degree of flexibility to create an investment portfolio that is better aligned with your financial situation, goals and risk tolerance. Also, you may be able to lower your fees and expenses with lower-cost investments.
2. Easier to manage retirement savings in one place
Today’s average worker stays at each job for 4.6 years, according to the Bureau of Labor Statistics. That can mean having to track and manage several retirement accounts over the course of your career.
You can keep all of your retirement savings in one place by consolidating them in an IRA. It makes it easier to manage your assets under a cohesive investment strategy as well as monitor your progress.
3. Maintain tax benefits
An IRA provides similar tax advantages that are typically offered in 401(k) plans or other retirement accounts. Earnings in a Traditional IRA are tax-deferred. With a Roth IRA, your earnings and withdrawals are tax-free; however, any pre-tax dollars you convert to a Roth are subject to ordinary income tax.
4. Avoid penalties and keep your money growing
If you withdraw your savings from a 401(k) or other retirement account, it may be subject to income taxes and a 10% early withdrawal penalty if you’re under age 59 ½ (see below for information regarding an exception to this rule). Funds directly transferred to a Traditional IRA, on the other hand, are not subject to income taxes or the early withdrawal penalty. Additionally, assets rolled over to an IRA can remain invested and can continue to grow.
5. Higher level of guidance
If you choose to have someone manage your retirement assets for you, an IRA can give you access to a wider range of professional services. Often, advisers won’t service 401(k) plans or will only provide suggestions, requiring you to implement those recommendations. (Advance Capital does directly manage 401(k) plans for individual workers. If you need assistance with your 401(k) plan, contact us.)
When your savings are in an IRA, your financial adviser can help you choose investments that he or she believes appropriately fit your financial needs. In employer retirement account, what you see is what you get. Additionally, an adviser can directly make changes adjustments to your portfolio as market conditions or your needs change.
Bonus: When an IRA rollover may not make sense – the “Age 55 Rule”
If you separate from your employer or retire in the year in which you turn age 55 or older, but are under age 59 ½, you might choose to roll over only a portion of your 401(k) to an IRA. In this situation, you can take withdrawals from your 401(k) without incurring the 10% early withdrawal penalty, even though you're under age 59 ½. This exception is commonly referred to as the “Age 55 Rule.”
Some individuals opt to move most of their 401(k) to an IRA but leave behind a small amount of savings to use as a retirement emergency fund. This could give you greater flexibility of income. You will have to balance this option against the benefits of an IRA.