Top Reasons to Roll Over Your 401(K) to an IRA

by | Jun 3, 2024 | Uncategorized

Whenever you change jobs, you have several options with your 401(k). You can leave it where it is, transfer it into your new employer’s 401(k) plan (if one exists), or roll it over into an individual retirement account (IRA).
For most people, rolling over a 401(k) into an IRA is the best choice. Below are several reasons why.

1. More Investment Choices

Your 401(k) is limited to a few planets in the investment universe. In all likelihood, you have the choice of a few mutual funds—mostly equity funds and a bond fund or two—and that’s it. However, with an IRA, most types of investments are available to you – not only mutual funds and ETFs, but also private investments and custom structured notes, plus many other options.
You can also buy and sell your holdings anytime you want. Some 401(k) plans limit the number of times per year you can rebalance your portfolio.

2. Better Communication & Planning

If you leave your account with your old employer, you might be treated as a second-class citizen. It might be harder to get communication regarding the plan or get in touch with an administrator.
If you roll your 401(k) to an IRA with an advisor, they can not only provide information on the account to you promptly, but also better incorporate the account into your goals and overall financial plan.

3. Tax Planning Advantages
With your 401(k) rolled to an IRA, you can take advantage of tax planning opportunities such as converting pre-tax IRA dollars to a Roth IRA. This strategy may make sense if your income is low in a certain year, which would allow you to convert IRA money at a low tax rate to a Roth IRA, creating a bucket of tax-free money that can grow and ultimately be drawn on tax-free in retirement.

4. Fewer Rules

Understanding your 401(k) is no easy task since each company has a lot of leeway in how they set up the plan. In contrast, IRA regulations are standardized by the IRS.
One often overlooked difference between a 401(k) and an IRA has to do with IRS rules regarding taxes on distributions. The IRS requires that 20% of distributions from a 401(k) be withheld for federal taxes. When you take a distribution from an IRA you can elect to have no tax withheld. While this option is available to you for IRA distributions, it’s probably wise to have some tax withheld, rather than potentially winding up with a big tax bill at the end of the year, and possibly interest and penalties for underpayment. An advisor can help you determine an amount to withhold.

5. Estate Planning Advantages

Upon your death, there’s a good chance that your 401(k) will be paid in one lump sum to your beneficiary, which could cause income and inheritance tax headaches. It varies depending on the particular plan, but most companies prefer to distribute the cash fast, so they don’t have to maintain the account of an employee who is no longer there. Inheriting IRAs has its regulations too, but IRAs offer more payout options.

If you roll your 401(k) to an advisor, they can help to ensure beneficiaries are set up correctly with both primary and contingent beneficiaries in place. If kept under your previous employer’s 401(k) plan, your advisor would have no visibility to beneficiaries. If beneficiaries are not set up, your account will go through probate, which is costly and makes your finances public record. It comes down to cost, control, and flexibility.

6. Required Minimum Distributions
Upon reaching age 73 (increasing to age 75 in 2033), you are required to begin taking Required Minimum Distributions (RMDs) from pre-tax IRAs and 401Ks. Custodians of former employer 401Ks do not actively alert you to take RMDs, and if you miss an RMD, the penalty can be steep. Furthermore, the more previous employer 401Ks you have, the harder it is to calculate the correct RMD to take each year.

On the other hand, if you roll 401Ks to an IRA with an advisor, they will work with you directly to take the correct required minimum distribution every year.

Ready to start planning for a brighter future? Call today at (408) 840-4030, or contact our team online.