Should You Rollover Your 401k to an IRA During Retirement?

When it comes to retirement planning, there is no one-size-fits-all approach that our retirement plan advisors would recommend for all clients. We’re often asked if a 401k or an IRA is the better decision, and our answer is: it depends. But with 77 percent of Americans investing in a 401k plan, and many debating rolling it over into an IRA during retirement, we decided to dive a little deeper into this topic and help you find the plan that works for your retirement.

401k vs Rollover IRA: What’s the Difference?

What is a 401k?

A 401k is a retirement savings plan offered by many employers. It allows you to choose a percentage of your pre-tax paycheck to invest into your 401k, where it will gather interest and grow. When you retire, you can withdraw the money from your 401k retirement plan, but you will have to pay income taxes on your withdrawals.

What is a Rollover IRA?

A Rollover Individual Retirement Account (or Rollover IRA) serves as a vehicle for transferring funds from former employer-sponsored retirement plans, like 401(k)s, into an individual retirement account (IRA).

You can open a Rollover IRA with a financial institution, such as a bank, brokerage, or mutual fund company. You can contribute pre-tax money to the Rollover IRA either from your paycheck or from your own savings, and upon your retirement, you can withdraw the money with income taxes.

Note that we are talking about traditional IRAs and not ROTH IRAs, which is a separate topic, in addition to the less common Roth 401K’s.  

Pros and Cons of Rollover IRA

There are both pros and cons to rolling over your 401k to an IRA, and the best decision for you will depend on your individual circumstances. Our retirement planning experts at Morris Financial planning have you covered with the most up-to-date information and guidance to steer you in the right financial direction.

Pros Of Rolling Over a 401k to an IRA for Retirement Planning

More Investment Options

IRAs typically offer a wider range of investment options than 401k plans, which are limited to the options chosen by your employer. This means that an IRA may provide investment opportunities that better meet your needs and risk tolerance than you could find with a 401k plan. 

The investment options provided by an IRA include:

  • Stocks: Stocks are shares of ownership in a company. When you buy a stock, you are essentially purchasing a small piece of a company. Stocks can be volatile, but they have the potential to grow in value significantly over time.
  • Bonds: Bonds are loans that you make to a company or government. Bonds are typically less volatile than stocks, but they also offer lower potential returns.
  • Certificates of Deposit (CDs): CDs are savings accounts that offer a fixed interest rate for a set period of time. CDs are very low-risk investments, but like bonds, they also offer lower potential returns.
  • Exchange-Traded Funds (ETFs): ETFs are baskets of stocks or bonds that are traded on an exchange. ETFs offer diversification and low fees, making them a popular choice for IRA investors.
  • Mutual Funds: Mutual funds are baskets of stocks or bonds that are managed by a professional money manager. Mutual funds offer diversification but also offer professional management. However, they sometimes come with higher fees than ETFs.

Lower Fees and More Control

IRAs typically have lower fees than a 401k retirement plan. This allows you to save money over time. In addition, IRA’s provide more control over your investments. You can choose when to buy and sell, and you can change your investment mix as your needs change, totally customizing your funds to your unique needs.

Do note that if you have a financial advisor, they are likely charging their fee on your IRA, which may increase the total fee you pay if you choose to roll it over. This should be analyzed very carefully by your financial advisor before executing a rollover. In fact, the Department of Labor released a rule last year stating that advisors must disclose all of the additional fees you might pay by rolling it over.

Portability and Consolidation

Unlike the employer-sponsored 401k plan, IRAs are portable. This means you can take them with you if you change jobs, without having to worry about transference issues, extra paperwork, or starting fresh with a new account. This can be a valuable benefit if you want to consolidate your retirement savings in one place.

Qualified Charitable Distributions

Both IRAs and 401k plans have Required Minimum Distributions (RMDs) after a certain point, but only IRAs allow you to donate money from your plan directly to a charitable organization for your RMD. These donations, known as Qualified Charitable Distributions (QCDs), can lower your adjusted gross income in addition to counting toward your RMD and supporting a cause. For those taxpayers who do not itemize deductions and still want their charitable donations to count for something, this is a powerful tax strategy.  

If you expect to be close to the boundary of your tax bracket upon retirement, if you aren’t sure how to spend your RMD, or if you plan to engage in charitable giving, QCDs could be a powerful benefit for your retirement plan.

Cons of Rolling Over a 401(k) to an IRA for Retirement Planning

No Access to Loan Options

401k plans typically offer loan options, which allow you to borrow money from your account before you reach retirement. IRAs do not offer loan options, so you will not have this option available to you if you need to access your money before retirement. Consider your current financial situation, the factors at play in your financial security, and potential risk items on the horizon that could impact the value of this feature for your situation.

Less Creditor Protection

IRAs offer less creditor protection than 401k plans. This means that your IRA assets may be subject to creditors if you file for bankruptcy or you are named in a lawsuit. 401k plans, on the other hand, are protected by the Employee Retirement Income Security Act (ERISA), so they are protected from seizure by federal law.

Required Minimum Distributions (RMDs)

IRAs require you to start taking required minimum distributions (RMDs) at age 72 (73 if you reach age 72 after Dec. 31, 2022). If you have a 401k plan, you do not need to make RMDs from your current employer’s 401k until you officially stop working for them. Thus, you can keep your money in the account and let it grow tax-deferred for a longer period of time compared to an IRA.

Limited Backdoor Roth Option

Roth accounts have an income limit for who can contribute to them. The Backdoor Roth option refers to a strategy for these high-income earners — though they can’t contribute directly to a Roth account, they can contribute to a regular IRA and convert it to a Roth. If you have an empty IRA then you can easily perform this option without any tax consequences at all.  If you roll your 401k into your IRA, then your Backdoor ROTH maneuver suddenly gets a lot more complicated.  Before you make any major changes to your retirement plan, be sure to consider how it could impact other options, like the backdoor Roth, that you may be interested in pursuing.

Whether or not to roll over your 401k to an IRA during retirement is a personal decision and depends on your needs and preferences. There are both pros and cons to consider, and the best decision for you will depend on your individual circumstances.

If you are considering rolling over your 401(k) to an IRA, we recommend that you speak with a certified financial advisor. We can help you assess your individual needs and help you make the decision that is right for you. 

Retirement Planning Tips for Making the Decision to Roll Your 401(k) Over to an IRA

The decision of whether or not you should roll over your 401k to an IRA during retirement can be complex. A few points to consider when making this decision would be your control preference, your investment needs, and any concerns you may have regarding RMDs. If you are looking for more investment options or lower fees and you want more control over your investments, then an IRA may be a good choice for you. If you are concerned about RMDs, then you may consider keeping your 401k in your former employer’s plan. 

If you are still unsure about what you want or what will benefit you and your lifestyle the most, speak to a certified financial advisor. At Morris Financial Concepts, we are experts on retirement planning and can help you assess your financial situation, needs, and preferences. Contact us today to speak to one of our retirement plan advisors.