Ignoring your past employer’s 401(k) can be easy but rolling it over to an IRA could be just as easy and more beneficial in the long run.
When you leave a company you have a multiple options with your 401(k). You can roll over your 401(k) into an IRA, keep it with your previous employer’s provider, roll it over to your new employer’s plan or cash it out. We do not recommend cashing out your 401(k) because of early withdrawal penalties and tax consequences.
There are several benefits of rolling your 401(k) over to an IRA; the first being more investment options. 401(k) plans vary from company to company and unfortunately many have limited investment options usually consisting of high cost mutual funds. Rolling these funds into an IRA often gives you access to a wider variety of investment options consisting of stocks, bonds, exchange-traded funds, structured investments and more. If you roll over your previous 401(k) to an existing Traditional IRA you are still eligible to make contributions up to the annual limit until age 70 ½. Rolling your funds into an IRA also allows for penalty-free withdrawals for a first-time home purchase or qualified education expenses if you are under the age of 59 ½. One potential negative to rolling over your 401(k) is losing the ability to take a loan against your account. However, we generally do not recommend taking out a loan against your retirement savings.
Lower fees are another benefit, not only the fees associated with the funds you are invested in, but moreover the plan administration fees associated with a 401(k). Fund fees from managing and marketing mutual funds, called 12b-1 fees, within your plan are often hidden as they are subtracted from gains or added to losses before calculating annual returns. Other costs associated with mutual funds that many investors are unaware of are the loads. These come in the form of front-end and back end. Front-end loads are deducted from the investment amount and as a result lower the size of your investment. A back-end load is a fee that investors pay when selling their mutual fund shares within a specified period of time. Other fees associated with most mutual funds consist of administrative fees, custodial fees, reinvestment fees, and the overall management fees. Fees associated with the 401(k) administration of the plan are not explicitly listed and can be divided up among all plan participants. Today, many brokerage accounts do not charge you for opening and maintaining an IRA account.
An important note to remember is when rolling over your 401(k) to a Traditional IRA you will not have to worry about paying taxes and you will still be able to reap the benefits of your money growing tax deferred. If you roll your funds from a 401(k) to a Roth IRA that is considered a taxable event and you will have to pay taxes on the amount you convert. Your money, however, will be free of federal taxes on your future earnings meaning you will never pay taxes on this money again.
Please contact us for a complimentary 401(k) review to discuss which course of action may be best for you and please contact your tax advisor for tax related advice.