Should you roll your 401(k) into an IRA?

Some retiring workers roll their 401(k) tax-deferred savings account into an Individual Retirement Account (IRA). There are good reasons to do so. But for those who are not retiring, the decision is not so clear cut. Here are some pros and cons to ponder.

In my neighborhood, for example, a local company with over 300 employees is being acquired by another company from Chicago. As a result, the employees of the acquired company are being offered a choice: they can roll over their existing 401(k) into a new plan offered by the Chicago company, roll their 401(k) into an IRA, or just take the money out, pay taxes and spend it.

The last option is the worst choice. The tax bill on such a lump sum would be quite large and if the employee is not yet 55 years old, an additional 10% tax penalty would be levied on the money as well.

Two reasons to roll over your money into an IRA is that you suddenly have an entire universe of investment options to choose from instead of the typical 10 to 20 choices normally listed in a company 401(k) menu. The second reason is that you will have more control over your retirement funds. 

Sometimes, you can also reduce costs, while at the same time improving your performance. Few 401(k)s offer the option to invest in index based exchange-traded funds (ETFs). Some of those ETFs charge a lot less than some mutual funds. This can be especially important to someone who contributes regularly to their plan over two to three decades. Studies have shown that in the past, total fees and expenses can amount to as much as 33 percent of your total retirement assets over a 25-year period.

But there are other reasons, depending on your circumstances, to simply roll over your 401(k) to another one. Some 401(k) plans offer stable-value funds, which are a low-risk option for an extremely conservative investor. These funds provide an attractive alternative to a typical money market fund. And unlike pure bond funds, they won’t get decimated if interest rates rise. 

Sticking with a 401(k) is also the best option if you plan to retire early. If you roll your money into an IRA and plan to start withdrawing before the age of 59-and-a-half years old, you will be charged a 10 percent penalty by the IRS. In a 401(k) plan, workers who leave their jobs in the calendar year they turn 55 or later can take penalty-free withdrawals. In both cases, however, you will still have to pay regular income taxes on your withdrawals. You can also take out a loan against your 401(k), but not from your IRA.

On the other end of the spectrum are guys like me, who don’t ever plan to retire. Ordinarily, at age 70-and-a-half, I would be required to take a required minimum distribution (RMD) from both my IRA and 401(k). If I continue to work past that age, however, not only can I continue to contribute but I am not required to take an RMD from my company 401(k). 

Bill Schmick is registered as an investment advisor representative with Berkshire Money Management.  Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM.