If you are fortunate enough to work for an employer who offers a 401(k), you probably also know that if you change jobs, you can roll the balance in your previous employer’s 401(k) into your new employer’s 401(k), assuming your new job offers this benefit. But even if your new company doesn’t have a 401(k) plan in place, you can roll those same funds into an IRA. There are several compelling reasons why rolling your 401(k) into an IRA may be a better move than simply going into your new company’s 401(k) plan.
1. An IRA may offer you more investment choices.
- Typically, 401(k)s limit your options to whatever mutual funds are represented by whomever set up your employer’s plan. But an IRA doesn’t have such limitations; individual stocks, exchange-trade funds (ETFs), and other viable vehicles can be purchased and owned within an IRA, subject to suitability.
2. You have the option of a Roth IRA.
- While Roth 401(k)s exist, they are not offered by many employers. But anyone who is eligible can own a Roth IRA. This can be a smart move if you believe that you will be in a higher tax bracket upon retirement, or even if you believe that taxes in general will be higher by the time you reach retirement age. Because a Roth is taxable during accumulation but not taxable upon withdrawal (basically, the opposite of a traditional IRA), you can take advantage of lower taxation now and keep your retirement plan assets in a qualified classification.
3. You can contribute to both a 401(k) and an IRA.
- You may decide to roll only a portion of your 401(k) assets into your new company’s plan, and then place the rest in an IRA. If your previous employer’s plan allows it, you might even want to keep a portion of your balance there, if you are happy with the return you are receiving. In either case, you can then contribute to both the 401(k) and the IRA, as long as you remain within your annual contribution limits. This isn’t exactly having your cake and eating it too, but it’s close!
4. A Roth IRA allows withdrawals.
- Traditional IRAs do not permit borrowing or penalty-free withdrawals other than the once-a-year, 60-day rule. But there are provisions for withdrawing funds that you have put into a Roth IRA if the funds are for certain specific uses. Taxes and penalties can apply to the earnings for Roth IRA accounts less than five years old, though, so before you do this, be sure to consult a qualified tax advisor.
5. Fewer Rules.
- While 401(k) plans allow companies significant leeway in the rules governing their plans, IRAs are all subject to the same set of standards put forward by the Internal Revenue Service. Level playing field, same rule book.
6. Estate Planning Options.
- Many 401(k)s allow only for a lump-sum payment in the event of your death; IRAs have more flexibility and options.
7. No Cost for the Rollover.
- While it costs you nothing to roll the funds into the IRA, you should still be aware of any transaction or acquisition costs associated with the investment of your funds within the IRA account.
As with any investment strategy or change in your accounts, you should consult a trusted financial advisor—and, in the case of retirement accounts, a qualified tax professional—before deciding if a rollover to an IRA is right for you. But the above advantages can certainly make it worth your while.
Stay Diversified, Stay the Course!