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Retirement savings don’t disappear when you change jobs. They’re yours. You can carry them to the new employer by rolling them into their 401(k), or you can do a 401(k) rollover to IRA. The latter option comes with several advantages and lower fees in most cases. 401(k) to 401(k) rollovers may seem simpler, but the IRA option is certainly one to consider.
What is an IRA?
An individual retirement account (IRA) is a retirement savings account offered by financial institutions to provide tax advantages on retirement savings. Unlike 401(k) or pension plans, IRAs are typically self-managed. That gives you the latitude to invest in the funds you choose rather than selecting portfolios constructed by plan administrators.
There are two types of IRAs. A traditional IRA is one where contributions are made pre-tax, deferring any tax liability until the funds are withdrawn in retirement. A Roth IRA is built with after-tax money, so withdrawals are tax-free. The IRS regulates these funds, which also places annual contribution limits on them. The 2023 limit is $6,500 ($7,500 if you’re over 50).
Advantages of rolling a 401(k) into an IRA
- More control over investments: IRAs are self-managed, so you can choose the stocks and ETFs you want to invest in. This differs from 401(k) or pension funds, where the investments are selected on your behalf based on your pre-determined risk tolerance.
- Lower administrative fees: Eliminating the need to manage investments also lowers administrative fees. IRAs are cheaper to maintain than 401(k) accounts, and those cost savings are passed on to you. They add up to a significant amount over time.
- Additional retirement savings: The IRS has maximum annual contribution limits for retirement savings accounts. Rolling your old 401(k) into an IRA while contributing to a 401(k) at your new employer expands your retirement savings bandwidth.
- Standardized IRS regulations: Employers have a lot of autonomy when setting up the rules for a 401(k) or pension plan. Regulations for IRAs are standardized by the IRS, so you always know exactly what your options are.
- Easier distribution to beneficiaries: To cut down on the cost of managing your plan, a 401(k) plan administrator is more likely to distribute funds to a single beneficiary when you pass away. IRAs allow you to set up multiple beneficiaries.
- Roth conversions: Traditional IRAs can be easily converted to Roth IRAs. This creates a tax liability in the year the conversion is done, but it eliminates the tax burden that would have been there in retirement. Distributions from a Roth IRA are tax-free.
The Bottom Line
Carrying over a 401(k) into an IRA has several advantages. You gain more control over your investments, lower your administrative fees, and create an additional retirement savings account. IRAs have standard regulations set by the IRS, so there are no surprises. The funds are easier to distribute to multiple beneficiaries, and you can convert a traditional IRA to a Roth IRA if you want to eliminate tax liabilities when you’re in retirement.
Sources
https://www.investopedia.com/articles/personal-finance/071715/8-reasons-roll-over-your-401k-ira.asp
