One question that I seem to be getting more and more lately is either: “I’ve retired, should I keep my money in my 401(k) or roll it into an IRA?” or “I’ve changed jobs, what should I do with my old 401(k)?”. Those are great questions and led me to put together this (hopefully) simple comparison of those two options.
The caveat I need to make before this is that one option is not always correct for everyone. Leaving your money in a 401(k) or rolling it into an IRA depends on your own unique situation which is why it’s important to consult with a financial advisor before making a move. With that warning, hopefully this list can give you a pretty good idea about what would be best for you.
Reasons to Leave Your Money in Your Company’s 401(k)
1. If you’re retiring early. If you are 55 or older and have left your employer but kept your money in their 401(k) plan, you can take an “early-access distribution”. This allows you to withdraw money while avoiding the extra 10% penalty you would be charged on distributions before age 59 ½ if you had instead taken the money out of an IRA.
2. If you’re retiring later. The IRS requires individuals to begin taking required minimum distributions (RMD) from their tax-deferred accounts (accounts funded with money you haven’t paid tax on yet like a 401(k) or an IRA) beginning at age 70 ½. One way around this rule is the “still-working exception” which states if you are still working at the company where your 401(k) assets are, you can delay your RMD from that 401(k) until you retire, which may be later than age 70 ½. Whereas if you had rolled the assets into an IRA you would have to take the RMD regardless of if you’re still working or not. So, if you believe you will work longer than age 70 ½ it would be wise to not take anything out of your 401(k) (some plans allow you to take funds out at age 59 ½ even if you’re still employed), and to prioritize your savings into the 401(k) not an IRA.
3. You want to manage it yourself but don’t want to get too complicated. This point could go either way, but if your employer has a solid 401(k) plan with good investment options, and you would like to minimize fees by managing the portfolio yourself, it could be better to leave your money in the 401(k). Most plans will pre-screen funds and provide you with a list of selected investment options. This, again, can be good or bad (see item 1 in the next section), but if the funds are good, it can allow you to manage your portfolio on your own without having to do all the research to pick your own funds as you would in an IRA.
4. You need creditor protection. This one is not as common and is a little more complicated but typically 401(k)’s are the gold standard of creditor protection due to a federal law called ERISA. This law covers all aspects of 401(k)s and one of its provisions is an “anti-alienation” clause which basically forms a wall around the account keeping almost all creditors out. Typically, the only people who can come after your 401(k) are the IRS or an ex-spouse during a divorce proceeding.
Reasons to Roll Your Money Into an IRA
1. You would like better investment options. This is one of the main reasons many choose to leave the 401(k) upon retirement or job change. In a 401(k) your investment options are limited, and many times include under performing and expensive funds with no lower cost/index alternatives. One of the main benefits of an IRA is you can invest in almost anything including index funds, stocks, individual bonds, pretty much anything besides items like antiques, life insurance, old coins…etc. This allows you to build a much more customized portfolio and could lead to significantly lower expenses if you do not have access to index funds in your 401(k) plan.
Another commonly overlooked factor is that in 401(k)s bond fund offerings are typically just one or maybe two funds. As you approach retirement and bonds become a larger part of your portfolio, those one or two funds are typically not the best options. In an IRA you have access to an entire universe of fixed income tools including individual bonds, CDs, international bonds, high yield bonds…etc which enable you to keep that portion of your portfolio diversified.
2. You don’t want to worry about managing it yourself. In most cases if your money is inside a 401(k) you typically are the one responsible for making the investment elections and changes. However, if you move the money into an IRA you have the option to hire an advisor (like me!) to take over the actual management of the account. This along with point #1 can hopefully lead to building a better portfolio that is more customized to your personal situation than what you can do in a 401(k).
3. More withdrawal options. If you have retired and plan on taking monthly withdrawals from your retirement savings some 401(k) plans can be a bit inflexible. Plans vary from company to company but they could limit the ability to withdraw money to just quarterly or annually which may not be a prudent option for you once you’ve retired. In an IRA withdrawals are very simple. Whether you are working with an advisor or managing it yourself, you can set up standard monthly withdrawals to replace your paycheck, or you can simply withdraw money whenever you feel like it with no restrictions.
4. You aren’t too sure about your former company’s future. One issue I come across every so often is people who have left money in old employers 401(k) plan and forget about it. That company then gets bought by another company, who then merges with another company, and before they know it they have no idea where their 401(k) assets are anymore! Although you can track them down it can be a burden. When I have a client who is not too sure about their former company’s future, or if they change jobs frequently and it’s difficult to keep track of all the accounts, I typically recommend they open up an IRA and get their money out of those former employer plans and into their own personal account.