If you’re changing jobs, one of the biggest financial decisions you’ll face is what to do with your old employer’s 401(k). For the 67% of Americans with a defined contribution retirement plan — typically a 401(k), 403(b) or 457(b) — the decision often involves whether to roll over these funds into an IRA. Other options include rolling over the funds to your new employer’s plan, cashing out or leaving the old 401(k) as-is.
A rollover involves transferring assets from one retirement account to another, such as moving funds from a 401(k) to an IRA. This process is common during job changes or retirement, with over 5.6 million people rolling a combined $618 billion into IRAs in 2020, according to IRS data.
Given that a rollover can be one of the largest financial transactions many people make, it’s crucial to consider various factors before deciding.
What to Consider Before Rolling Your 401(k) into an IRA
Investment Options
Deciding whether to keep your 401(k) or roll it into an IRA involves evaluating the range of available investment options. Most 401(k) plans offer a relatively limited selection, many plans offer fewer than 20 options, often consisting of mutual funds chosen by your employer.
In contrast, IRAs provide a much broader range of investment choices. You can select from thousands of exchange-traded funds (ETFs), mutual funds, individual stocks, bonds, certificates of deposit (CDs) and other investment vehicles including alternative assets. However, this wider range can be overwhelming, so it’s essential to carefully research options that align with your goals or consider professional management with a financial advisor.
If you’re satisfied with the investment options in your 401(k), it might make sense to keep the funds there. Conversely, if your 401(k) offers limited choices or has not performed well compared to similar options, an IRA may provide access to a broader range of investment options.
Costs
Understanding the overall fees associated with your 401(k) — including administrative and investment fees — is essential. Generally, 401(k) plans benefit from institutional pricing, which can result in lower investment fees than IRAs. However, if your 401(k) has high fees or poor-performing investment options, rolling over to an IRA might provide access to lower-cost mutual funds or ETFs and better-performing investments. Even a small difference in fees can significantly impact your retirement savings over time.
Flexibility and Access to Funds
When considering the flexibility and access to funds, it’s important to compare the advantages of 401(k)s and IRAs.
- 401(k) benefits
- Loan access: 401(k) plans offer the option to borrow against your retirement savings, which is not available with IRAs. While only about 1% of plans allow loans after leaving an employer, this feature can be useful if you roll over to a new employer’s 401(k). Loans typically must be repaid within five years to avoid penalties and taxes, and leaving your job may require immediate repayment or result in penalties if not repaid on time.
- Divorce settlements: Both 401(k)s and IRAs can be divided during a divorce settlement, through a QDRO a 401(k) allows the receiving spouse to access the funds without early withdrawal penalties before age 59½, whereas IRA withdrawals could incur a 10% penalty.
- Retirement after age 55: A 401(k) allows penalty-free withdrawals if you retire or leave your job after age 55, providing flexibility that can be critical for early retirees. While IRAs offer an exception through the 72(t) rule, which allows for penalty-free early distributions, it comes with certain requirements. Failing to meet these conditions can result in retroactive penalties, making it a less flexible option than a 401(k) for early retirement.
- IRA benefits
- Simplicity and control: Rolling over to an IRA can simplify managing multiple retirement accounts and give you more control over investment options, asset allocation and required minimum distributions.
- Penalty-free withdrawals before age 59½: IRAs offer some flexibility for penalty-free withdrawals before age 59½ under certain conditions such as qualified higher education expenses, first-time home purchases (up to $10,000), or paying for health insurance during periods of extended unemployment (at least 12 weeks). Consult with your financial advisor to see whether you qualify for these exceptions.
- Retirement withdrawals: IRAs can provide greater control over both the amount and timing of withdrawals in retirement. In 2022, only 61% of 401(k) plans allowed periodic or partial withdrawals for retirees, and 55% permitted installment payments, according to the Plan Sponsor Council of America.
- Rebalancing flexibility: IRAs can provide greater freedom to rebalance investments without the restrictions that some 401(k) plans impose, such as holding periods between rebalancing actions.
Working with Advisors
If your employer’s 401(k) plan includes advisory services through the plan sponsor, financial advisors outside of that arrangement are typically restricted from advising on individual assets within the 401(k). This is because the plan sponsor often has an agreement with a specific advisor or recordkeeper who provides guidance on the plan’s investments. External advisors generally cannot manage or provide tailored advice on your 401(k) assets. By contrast, IRAs allow you to freely work with any financial advisor, providing more flexibility and personalized guidance that may not be available with 401(k).
Creditor Protection
Rolling over a 401(k) to an IRA can reduce your creditor protections. Generally, 401(k) plans are protected by federal law, offering unlimited protection from creditors in bankruptcy and civil lawsuits, with some exceptions, such as divorce settlements or debts owed to the IRS.
In contrast, IRAs do not have the same level of federal protection, and their safety from creditors depends on state laws. If you file for bankruptcy, the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCA) protects up to $1,512,350 in traditional and Roth IRA assets. Properly executed rollover IRAs are fully shielded from creditors in bankruptcy.
Company Stock
When planning for retirement, how you hold company stock (stock in the company that you are employed) can significantly impact your taxes. One strategy often overlooked is Net Unrealized Appreciation (NUA), which can reduce the tax burden on company stock. While both 401(k)s and IRAs offer tax-deferred growth, they treat NUA differently:
- 401(k): If you withdraw company stock from your 401(k) and take a lump-sum distribution, you only pay ordinary income tax on the cost basis (what you originally paid for the stock). The NUA — the difference between the cost basis and the market value at distribution — is taxed at long-term capital gains rates, which are often lower than ordinary income tax rates. This can be a significant tax advantage for employees who hold onto company stock in their 401(k) for a long period, have a low cost basis and the stock has appreciated significantly, as the appreciation portion (NUA) will be taxed at the lower capital gains rate instead of the potentially higher ordinary income tax rate.
- IRA: If you roll your company stock from a 401(k) into an IRA, you lose the ability to take advantage of NUA tax treatment. Instead, all future withdrawals are taxed as ordinary income, which can be at a higher rate than capital gains.
Net Unrealized Appreciation can be one of the most complex aspects of a 401(k) rollover. There are numerous nuances, especially in real-world scenarios, making it essential to consult with a financial advisor or qualified tax professional. Their experience can help you make an informed decision that best aligns with your financial goals.
Special Considerations for Forced Rollovers
A forced rollover occurs when employers initiate a force-out process to transfer former employees’ 401(k) balances into an IRA if no action is taken after leaving a company. This has historically applied to accounts between $1,000 and $5,000, but in 2024, the SECURE Act 2.0 increased this threshold to $7,000. Companies are required to notify employees before initiating a force-out and can only proceed if the employee fails to act. A 2014 report from the U.S. Government Accountability Office revealed that these forced rollover IRAs often yield low returns between .01% and 2.05%, with high fees eroding account balances over time.
The Bottom Line
Deciding whether to roll over your 401(k) into an IRA hinges on your unique financial situation and goals. While IRAs offer greater flexibility in investment choices and withdrawal options, 401(k)s provide certain advantages like penalty-free withdrawals for early retirement at age 55, stronger creditor protection and specific tax benefits for company stock. It’s essential to weigh these factors carefully. Your final choice should reflect a comprehensive understanding of how each option aligns with your specific circumstances and objectives.
Weaver Capital Advisors’ experienced professionals are prepared to work closely with you to design investment strategies tailored to transform your retirement goals into reality. Contact us today — we’re here to help.
Written by: Molyka Nhek & Patrick Norfleet