Doing an IRA Rollover Can Save on Fees and Give You Better Options
- A rollover is when you move the money you saved in your 401k at work to an IRA you control. Most rollovers happen when people retire or get new jobs.
- Direct rollovers are relatively simple and do not trigger any new taxes.
- Doing a 401(k) rollover can frequently help you save on fees and take advantage of better investment options.
Introduction: 401k Rollover Options
If you are leaving a job and you’ve saved in a 401(k) or similar plan, you’ll want to figure out what to do with the money you’ve accumulated while at that job. Frequently, but depending on the 401k rules, you can leave you savings where it is. If you choose to move the money from a 401k to an IRA, this is called a “rollover” and can often be a good idea.
You can decide which option to choose based on four factors:
- Will I owe taxes on my rollover?
- Can I save on annual fees?
- What about my investment options?
- How easy is it to manage your money?
- Bonus: The One Thing You Don’t Want To Do
The government gives people tax breaks on retirement savings. But different kinds of retirement accounts have different tax breaks. When you are doing a rollover, you can decide to pay taxes now, or keep deferring them until retirement.
401k to Traditional IRA Rollover
A direct rollover is the most common type of rollover and is done by your 401k plan administrator. You won’t owe taxes if you do a direct rollover from a 401k to a Traditional IRA. You will pay taxes when you retire and start to draw money out.
Some people chose to do an indirect rollover from a 401k to a Traditional IRA. An indirect rollover is when you withdraw the money from your 401k and hold it for 60 days or less before depositing it into the same or another 401k or IRA. Usually people do an indirect rollover if they need a loan of their retirement money. Indirect rollovers can trigger taxes or tax-reporting depending on how you do them.
401k to 401k
If you roll your 401k balance over to another 401k at a new job, you won’t pay taxes. You will pay them when you retire and start withdrawing the money.
401k to Roth IRA
You can do a rollover between a 401k and a Roth IRA, but it requires that you make a stop at a Traditional IRA first. You do a 401k rollover first and then a Roth IRA conversion. You will pay taxes on the money now. But when you withdraw the money after you are retired, you won’t owe taxes. If you think your tax rate is higher now than it will be in retirement, it could be smart to roll over to a Traditional IRA. If you think your tax rate is lower now than it will be in retirement, it could be smart to roll over to a Roth IRA. Whether taxes are higher or lower depends on how much you earn and whether the government is raising or lowering taxes.
Fees can make a big difference on how much money you have when you retire. If you stick to low cost investments in your IRA, you will probably pay less in an IRA than in a typical 401k.
There are two important kinds of fees when it comes to rollovers. One kind is the fee that you are charged for your account. The other is the fee on the underlying investments — the mutual funds or ETFs — in your account.
Your 401k administrators should be able to give you a total cost for your retirement plan, in terms of the percent of your assets that you are paying. It will include the fee on the account and for the funds. Costs for typical 401ks can range from very low — under .5% a year — to quite high, as much as 2%.
Most banks and brokerages charge nothing or a nominal fee for an IRA or Roth IRA. If you stick to low-cost mutual funds and ETFs, those with fees of less than .5%, you will end up paying less than in a 401k. Broad-based index bond and stock funds often are good choices.
Investment Quality And Selection
IRAs often have a wider array of mutual funds, ETFs and other investment products, like annuities, to pick from. 401ks might have a good selection, too. Make sure whatever option you pick has a selection of low-cost funds to pick from.
You might also wish to hire an investment advisor to help you decide which investments to hold in your retirement fund, whether it is an IRA or 401k. Be sure to include the cost of the advisor when you add up the fees you are paying.
How Easy Is It To Manage Your Money
Finally, you might find it easier to manage your money if it is all in one account. That could mean doing a rollover each time you leave a job. You could roll over into your next job’s 401k, if there is one. Or you could do a rollover into one IRA or one Roth IRA each time you switch.
Check your 401k’s rules on how easy it is to withdraw money or take out a loan. Some 401ks are more flexible than Traditional IRAs when it comes to withdrawal rules. If you withdraw money from a Traditional IRA before you are 59 1/2, the withdrawal is taxable. Often, withdrawals are taxed an extra 10%, with a handful of exceptions like for medical expenses and education. You can see a list of exceptions here.
Compare the IRA rules to your 401k rules to help you make a decision.
Roth IRAs offer the most flexibility of all. You can typically withdraw the total of your contributions with no penalty.
The One Thing You Don’t Want To Do
There is one other rollover option: Cashing out your 401k. But if you do that, you’ll be robbing your future self of the money you need to live on in retirement.