Pros and Cons of Rolling Over 401(k) to IRA

Find out the pros and cons of rolling over 401(k) to IRA, and the potential costs that you are likely to save or incur if you consolidate your multiple 401(k) accounts into one Individual Retirement Account.

3 min read

When you change jobs and settle in your new workplace, one common question that comes to mind is whether to rollover your 401(k) to a new Individual Retirement Account (IRA) or keep the funds in your former employer’s 401(k).

Most of the time, a new IRA has more benefits in terms of fees, investment options, and tax savings than a 401(k), but it is important to know the pros and cons of rolling over 401(k) to IRA before making the switch. The pros of rolling over 401(k) to IRA include wider investment options, lower fees, penalty-free withdrawals, and an opportunity to consolidate old 401(k)s into one location. The cons of rolling over 401(k) to an IRA include limited creditor protection, lost access to 401(k)s loans and delayed access to funds until you are 59 ½.

Pros of Rolling Over 401(k) to IRA 

Once you leave your former employer’s workplace, you no longer get an employer match on your 401(k) contribution nor are you required to continue making contributions to your former employer’s retirement plan. This is why rolling over your funds to IRA is the best bet to grow your retirement savings.

Here are some reasons why you should rollover your 401(k) savings to an IRA:

Pro: More Investment Options

One of the main benefits of an IRA is the wider investment selection that is available to investors. You can invest in stocks, bonds, commodities, REITs, etc. This allows you to diversify your portfolio in a way that increases your chances of earning a return on your investments even in unfavorable economic conditions.

In contrast, a 401(k) limits participants to a few hand-picked investments such as mutual funds and stocks, hence limiting their ability to invest in high-risk high-return assets.

Pro: Manage your assets in one location

A report by the Bureau of Labor Statistics shows that young baby boomers change jobs an average of 12 times during their working years. This means that a baby boomer nearing retirement may have a trail of 401(k) accounts. If you have multiple 401(k) plans, rolling them over to an IRA can help you consolidate the funds and make it easier to create a well-diversified portfolio.

Pro: Lower fees

Most 401(k) plans charge an annual fee of 1% to 3% of the total value of assets. You also pay other fees such as administrative fees for day-to-day account operations, management fees, and other costs, all of which reduce your investment returns. Although IRAs are not free of fees, it is easier to minimize these costs by choosing investments with the lowest costs.

Pro: Penalty-free withdrawals

An IRA allows participants to access no-penalty withdrawals for certain expenses such as medical expenses, college fees, and first-time home purchase. Although 401(k) accounts allow early withdrawals, you will have to pay large tax bills and penalties on the withdrawal amount. The IRS requires 401(k) plan administrators to withhold 20% of the total distribution for federal taxes, and there is a 10% early withdrawal penalty. When you withdraw funds from an IRA, you can choose to defer paying tax or decide the actual amount of tax to withhold depending on the assessed tax.

Pro: Low-cost investment options

When you roll over your 401(k) account, you can open an account with a Robo-advisor to lower your account fees. Robo-advisors make investment decisions based on algorithms, and they require minimal or no human intervention. This investment option is inexpensive because it uses mathematical rules or algorithms to automate trades. Robo-advisor investment accounts charge a 0.2% to 0.5% annual fee.

Cons of Rolling Over 401(k) to IRA

Even with the benefits that come with rolling over your 401(k) to an IRA, there are certain limitations that you should expect with your new retirement account. Some of these limitations include:

Con: Loss of access to credit facilities

Generally, 401(k) plans cap the number of times account holders can make withdrawals from their accounts. However, if you need funds urgently, you can take a 401(k) loan and use the retirement savings as collateral. This privilege is lost when you transfer your funds to an IRA, which does not offer loans. However, you can take an early distribution to pay certain expenses without paying taxes or early-withdrawal penalties.

Con: Limited Creditor Protection

If someone wins a lawsuit against you, the Federal Employment Retirement Income Security Act prevents such parties from accessing the funds in your 401(k) to settle their claims. However, IRAs do not enjoy the same level of protection as 401(k) accounts. A creditor may access your IRA funds up to a certain limit to settle their claims. Some IRAs may offer creditor protection up to a specific level, but these limits vary from state to state.

Con: Delayed Access to Funds

401(k) accounts impose a 10% penalty for withdrawals made before you turn 59 ½. However, there is an exemption to this rule: if you retire at 55 years, you can take a penalty-free withdrawal from your 401(k) account. This exemption does not apply to IRA accounts, and you will have to wait until you are 59 ½ to make withdrawals without paying a penalty.

Con: Should you Rollover to an IRA?

When deciding whether or not to rollover your 401(k) to IRA, you should weigh the pros and cons of rolling over 401(k) to IRA to determine the option that protects your assets. Remember, the funds in your 401(k) are your retirement savings, and you should make a decision that preserves your savings in your golden years. If you are ready to make the switch, use Beagle to find your 401(k) and see how much you can save by moving to a better IRA.