It’s one of the most common questions in financial planning. When you leave a job, should you roll over your 401k to an IRA? And, like most answers in financial planning, it depends.
Why Roll Over
An IRA allows you to invest in stocks, bonds, commodities, exchange traded funds (ETFs) and other alternative investments in addition to mutual funds. Most 401k plans restrict investments to mutual funds. Access to more asset classes can help you build a more diversified portfolio that can potentially increase risk-adjusted returns.
An IRA allows you to consolidate all your accounts in one place, making it dramatically easier to allocate assets and create a diversified portfolio.
It’s easier to withdraw money from an IRA whenever you need it, and to set up a regular income stream during retirement. Some 401k plans limit withdrawal frequencies; others have an all-or-nothing policy on taking out money.
When you do withdraw money, 401k plans have a mandatory 20% federal tax withholding; IRAs have no mandatory withholding. You still have to pay taxes on the distribution but, if you’re in a low tax bracket in retirement, it may not be 20%.
Two Issues You’ll Have to Think Carefully About
If the thought of managing your asset allocation and other money decisions on your own scares you, you may be better off moving it to an IRA so you can get professional advice. A financial advisor should cost you approximately 1% of your assets under management per year, and we believe it’s worth it.
If any of the money in your 401k was used to buy your ex-employer’s stock, you need to talk to a tax professional before making the decision to roll it over to an IRA. If there’s unrealized appreciation on the stock, you may want to move it into a taxable investment account at the same time the rest of your money is rolling over into an IRA, so that it qualifies for treatment as capital gains, which are taxed at a lower rate than income. Don’t try to do this one yourself.
When to Leave Your Funds in the 401k
An IRA can cost you the advantage of group buying power. Few individual IRAs are large enough to get the institutional rate, so you may have higher fees.
If you retire or get laid off between ages 55 and 59½, you can take penalty-free withdrawals from your 401k. An IRA makes you wait until 59½. With either choice you still have to pay income tax.
There are the highlights of the plusses, minuses and in-betweens. No matter what, the first thing to do is talk with your financial adviser about how a rollover, or the lack of one, fits in with your overall financial plan.
You may also be interested in:
The “Your Money” show replay on IRA Strategies
Jim Cahn’s Wall Street Journal article, Having Good Reason to Do an IRA Rollover“
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.