Employer-sponsored retirement plans such as a 401k and 403b are an excellent way to save for retirement. They have higher contribution limits than Individual Retirement Accounts (IRAs), and employers frequently offer some type of matching on those contributions.
However, once you leave the sponsoring employer, you are not allowed to make any more contributions to their retirement plan, and of course any matching stops as well. You can continue to hold the 401k and adjust your investments within it, but that’s about it.
An alternative is to roll it over into an IRA. An IRA is very similar to a 401k from a tax standpoint, but is not sponsored by an employer. Rolling over your funds involves liquidating your 401k and transferring the proceeds into an IRA, which you can then invest as you see fit.
Due to regulatory constraints, Palisade does not make recommendations to its clients regarding retirement plan rollovers. However, we can provide education on some of the potential benefits and drawbacks of rollovers, so you can make an informed decision. Many of our clients choose to roll over their 401k to an IRA.
Potential benefits:
- More investment options: IRAs generally (but not always) offer a wider array of investment choices than 401(k)s. IRAs allow you to invest in any publicly-traded security, whereas most 401(k)s offer only a handful of investment options.
- Lower fees: 401(k)s often (but not always) have higher fees. Meaning, the securities they offer for investment may have higher expense ratios than similar publicly-traded securities available via an IRA, or there may be other expenses incurred by owning the 401(k).
- More control: IRAs allow you to manage your investment mix, adjust your risk tolerance, locate assets more efficiently, and rebalance your investments as you see fit.
- Lower taxes: IRAs allow you to manage your tax exposure in various ways, such as via Roth conversions (transferring funds to a Roth IRA in lower-tax years) or Qualified Charitable Distributions (tax-free donations to charity after age 70.5)
- Simplified management: Consolidating multiple 401k accounts from different employers into a single IRA can streamline recordkeeping, address changes, beneficiary updates, and performance monitoring.
Potential drawbacks:
- More limited creditor protection: Both types of accounts receive protection from creditors, but the protection provided to 401k accounts is generally greater.
- Higher fees in some cases: Some employers subsidize 401k plan administration fees, and provide investment options that have competitively low fees.
- Delayed Access to Funds: For both a 401k and an IRA, you generally have to wait until age 59.5 to make penalty-free withdrawals. However, some 401k plans offer more flexible withdrawals or loans for hardships.
- Limits future backdoor Roth contributions: If you don’t have an IRA yet and still plan to work, you may be able to make backdoor Roth contributions. Once you have an IRA, this strategy becomes less advantageous.
Again, Palisade does not make recommendations to its clients regarding retirement plan rollovers. But hopefully the education above is helpful in your decision-making process. Please feel free to ask your Palisade advisor if you have further questions.
