If you own a 401(k) and have changed jobs, experienced divorce, or are at retirement age, no doubt you’ve heard of a 401(k) rollover. Put simply, a rollover is an IRS tax-qualified (tax-free) rollover of a 401(k) balance into your own Individual Retirement Account (IRA). But why do a rollover in the first place? What is the advantage?
First, let’s establish who can rollover a 401(k). If you left a job and either moved to a new one, or are unemployed, you are eligible to rollover your 401(k) balance into an IRA. The same is true for retirees. The reason is that you are no longer an employee participant in the retirement plan. Similarly, if you experienced divorce, you were never an employee of the company sponsoring the plan, so you have the right to roll the balance you received as a result of a divorce into your own IRA.
Finally, if you are over the age of 59 ½ and are still an employee, your 401(k) plan likely has a provision for a non-hardship withdrawal, which gives you the opportunity to rollover your plan balance into an IRA. According to a recent study from the American College of Financial Services,, 62% of retirement-age investors chose to rollover their 401(k) balance, and of the 38% that chose not to, over half of them just said they felt it was easier to leave their assets in the plan. Easy may not always be best.
So what are the benefits? Here are 5 reasons to consider rolling over a 401(k) into an IRA:
- Access to professional financial advice and service with financial advisor. Participants in a 401(k) plan are given 800 numbers, pins, and logins and are encouraged to use supplied plan information to make investment choices and contribution amounts. The call center representatives are not financial advisors and cannot help participants make financial decisions. If you are OK with deciding how much to contribute and how to invest, you may choose to remain in the plan. Of the 62% who decided to rollover their accounts, 80% worked with a financial advisor. An advisor can help tie your contribution rates and investment choices to a broader financial plan.
- Access to more investment choices. 401(k) plans are run by administrators who supply investments to the companies that offer them. They are hired by the companies, not the participants. In an effort to make the plan work for both the inexperienced and the experienced investor, these 401(k) plans offer relatively few investment options limited to cash, stocks, and bonds. If you rollover your 401(k) balance, your options expand to real estate, CDs, precious metals, customized investment strategies, and more. Most people don’t choose to invest in a 401(k) plan for its choices. Mostly, it’s just convenient.
- You can convert your IRA into a Roth IRA for tax-free retirement income. For some people in a lower tax bracket, or for young people with a long investment horizon, a Roth IRA may offer a tax benefit over the long haul. Roth IRAs act like IRAs until you need to make a retirement withdrawal. At that point, all withdrawals come out tax-free, unlike IRA and 401(k) withdrawals which are taxed as income. When you convert an IRA into a Roth IRA, you will pay income tax on the rollover amount, so it is important to understand whether it would make sense to do so and what the tax implications would be.
- You want to use the money to buy a house or to fund college. If you use an IRA to fund a down payment on a home, a couple can use up to $20,000 without paying tax on the withdrawal. You may also take withdrawals that are penalty-free for higher education, though those withdrawals will be subject to income tax and may be treated as income for purposes of determining financial aid. It is best to seek advice on either of these options to determine if they make sense for you.
- Fees may be lower. Investors do pay costs in 401(k) plans, whether employees or non-employees. Often, these fees are difficult to identify and quantify. If you are concerned about the cost of investing, it may be wise to evaluate the option of rolling over your (401) balance into a more cost-conscious IRA strategy, though IRA fees may not always be lower. One thing is for sure, you’ll know what the costs are and the benefit you are receiving from incurring them.
At the end of the day, 401(k) rollovers are not for everyone. Before rolling assets over from a qualified plan, like a 401(k), you should consider a few additional factors which may include, but are not limited to, access to penalty-free withdrawals in the form of borrowing from a 401(k), the fact that there are no required minimum distributions from 401(k) plans if you are over 70 ½ and still working, and any other factors that may be relevant to your specific circumstances that should be addressed with a financial professional. Also, check with your tax advisor if you are seeking distributions from a 401(k) or an IRA.