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Rollover 401k to IRA: Pros and Cons

If you have a 401k account from your previous employer, you might be wondering what your options are. One possibility is to rollover your 401k into an Individual Retirement Account (IRA). But is it a good move? In this article, we’ll explore the pros and cons of rolling over a 401k to an IRA.

Introduction

When you leave a job, you might have a 401k account with your previous employer. Depending on the rules of the plan, you might be able to keep your account with your former employer, but you might also have the option to roll it over to another qualified retirement account, such as an IRA. Rolling over your 401k to an IRA can have advantages and disadvantages, which we will explore in this article.

What is a 401k?

A 401k is an employer-sponsored retirement account that allows you to save for retirement on a tax-deferred basis. You contribute a portion of your paycheck to the account, and your employer may also contribute a match. You can choose from a menu of investment options selected by your employer, and the money grows tax-free until you withdraw it in retirement.

What is an IRA?

An Individual Retirement Account (IRA) is a retirement account that you can open on your own, regardless of whether you are employed or self-employed. Like a 401k, you can contribute to an IRA on a tax-deferred basis, meaning you won’t pay taxes on the contributions until you withdraw the money in retirement. There are two main types of IRAs: traditional and Roth. Traditional IRAs allow you to deduct your contributions from your taxes, while Roth IRAs are funded with after-tax dollars, but you won’t pay taxes on qualified withdrawals in retirement.

Reasons to rollover your 401k to an IRA

There are several reasons why you might consider rolling over your 401k to an IRA:

More investment options

401k plans typically offer a limited menu of investment options selected by your employer. By contrast, IRAs offer a much wider range of investment options, including individual stocks, bonds, mutual funds, exchange-traded funds (ETFs), and more.

Lower fees

401k plans often charge higher fees than IRAs because they include administrative fees and fees for the investment options offered. By rolling over to an IRA, you may be able to reduce your overall fees and keep more of your money invested.

Consolidation

If you have multiple 401k accounts from different employers, it can be difficult to keep track of them all. By rolling them over to an IRA, you can consolidate your retirement accounts and make it easier to manage your investments.

Control

When you have a 401k account with your employer, you are limited to the investment options selected by your employer. By rolling over to an IRA, you gain more control over your investments and can choose the options that are right for you.

Reasons not to rollover your 401k to an IRA

While there are advantages to rolling over your 401k to an IRA, there are also some potential disadvantages to consider:

Loss of creditor protection

401k plans have strong creditor protection under federal law, meaning that your account is generally safe from creditors in the event of bankruptcy. By contrast, IRA accounts have varying levels of protection depending on state law. If creditor protection is a concern for you, it’s important to research the laws in your state before making a decision.

Lower early withdrawal penalty

If you anticipate needing to withdraw funds from your retirement account before age 59 and a half, it may be more beneficial to keep your funds in a 401k. 401k plans typically have a higher early withdrawal penalty than IRAs, which may discourage you from dipping into your retirement savings too soon.

Required minimum distributions (RMDs)

When you turn 72, you are required to take minimum distributions from your retirement accounts each year. 401k plans have different rules for RMDs than IRAs, and if you have a 401k with a large balance, the RMDs could be substantial. By rolling over to an IRA, you may be able to reduce your RMDs and the associated tax burden.

How to rollover your 401k to an IRA

If you decide that rolling over your 401k to an IRA is the right move for you, the process is fairly straightforward. First, choose an IRA provider and open an account. Then, contact your former employer’s plan administrator to request a rollover of your account balance. The administrator will send a check made payable to your IRA provider, and you will need to deposit it into your IRA within 60 days to avoid taxes and penalties.

Things to consider before rolling over your 401k

Before you make a decision to rollover your 401k to an IRA, there are a few things to keep in mind:

  • Fees: Make sure you understand the fees associated with your new IRA account and compare them to your 401k fees.
  • Investment options: Consider the investment options available in your new IRA account and whether they align with your investment goals and risk tolerance.
  • Creditor protection: Research the creditor protection laws in your state to ensure that your retirement savings are safe.
  • Tax implications: Depending on the type of 401k you have and the type of IRA you open, there may be tax implications to consider. Consult a tax professional before making a decision.

Conclusion

Rolling over a 401k to an IRA can have advantages and disadvantages. While it may provide you with more investment options, lower fees, and greater control over your investments, it could also lead to the loss of creditor protection and a lower early withdrawal penalty. Before making a decision, it’s important to consider your unique financial situation and consult with a financial advisor.

FAQs

Q: Can I roll over my 401k to a Roth IRA?

A: Yes, you can roll over a traditional 401k to a Roth IRA, but you will need to pay taxes on the amount you convert.

Q: How many times can I roll over my 401k to an IRA?

A: There is no limit to the number of times you can roll over your 401k to an IRA.

Q: Can I roll over a 401k to an IRA while still employed?

A: It depends on your employer’s plan rules. Some plans allow in-service withdrawals or rollovers, while others do not.

Q: What happens if I miss the 60-day deadline for rolling over my 401k?

A: If you miss the 60-day deadline for rolling over your 401k, the funds will be considered a taxable distribution, and you may also be subject to a 10% early withdrawal penalty if you are under the age of 59 and a half.

Q: Can I roll over my 401k to an IRA and still contribute to the IRA?

A: Yes, you can contribute to an IRA even if you rollover funds from a 401k. However, there are limits to how much you can contribute to an IRA each year, and these limits are subject to change.

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