Should You Roll An Old 401k Plan To An IRA Or 401k?

Rolling your old 401k into a new 401k offers both advantages and disadvantages. Let's look at the good stuff first. 401(k)s have become a very popular way to help American investors save for their retirement. There are a variety of reasons for this.

First, since 401k plans are sponsored by employers, many employers will offer to match the contributions of their employees up to a specified amount. For example, if you make $100,000 and your employer offers a 5% dollar for dollar match, you could contribute $5,000 to the account and your employer would match that with another $5,000.

Secondly, 401k plans have high contribution limits. For 2024, you can contribute a maximum of $23,000 or $30,000 per year if you are 50 or older. Since 401(k)s are tax advantaged accounts, the high contribution limits can be very beneficial for some investors depending on their individual circumstances.

Finally, 401(k)s make it easier for investors to save for their retirement as contributions are made with automatic payroll deductions. It is easy to put retirement on the back burner (especially when you are young), but a 401k can force you to think about it and take action on it.

It is useful to understand the benefits of a 401k because they are the reason that you may consider a 401k rollover. If you have an old 401k and want to continue to get an employer match on your contributions, want a tax advantaged retirement account with high contribution limits, and want an easy way to save for retirement a 401k rollover may be a viable option for you.

On the flipside, 401k accounts also have disadvantages that you should consider before doing a 401k rollover. First, you are not in ultimate control of the account. Remember, 401k accounts are employer sponsored retirement plans.

This means that your employer gets to decide the investments that are offered through the plan, and the matching contribution amount that may have a vesting schedule. Additionally, your ability to contribute to a 401k is dependent on your employment.

For example, say that in your old 401k plan your employer offered a 5% match and 50 mutual funds that you could pick from as your investments. However, the new 401k plan that you would rollover the old 401k to only offers a 3% employer match and 25 mutual funds to choose from.

You may want to say to your new employer that they should offer more mutual funds and a higher match as that is what you got from your last 401k plan, but you are not able to do so. Secondly, 401k plans do not offer a broad investment selection.

Most plans offer a small selection of investment funds to choose from. For some investors this is fine, but if you want a broader investment selection, a 401k rollover may not be the most suitable solution. Some of these disadvantages of a 401k rollover can be solved with an IRA rollover which is discussed below.

IRAs, or individual retirement accounts, can be thought of as retirement accounts that are held outside of work. If you have an old 401k, you have the ability to roll that 401k into an IRA as opposed to rolling it into a new 401k.

An IRA rollover can solve some of the disadvantages that come from a 401k rollover. First, you have more control over an IRA than you do with a 401k since the account is held outside of work. For example, some 401k plans do not allow you to take partial withdrawals, meaning you are not allowed to take money out on a monthly or annual basis.

Instead, you would have to take your entire balance of your old 401k out of the account to access the funds, which can create a large tax bill depending on the balance of the account. IRAs on the other hand will typically be more flexible with withdrawal options.

Secondly, IRAs offer a significantly broader investment selection than 401k accounts do. IRAs typically give you access to hundreds if not thousands of investments compared to a small selection of investment funds offered by 401(k)s.

Although many investors will use their 401k plan to save for retirement, not all 401k plans are going to offer investments that are suitable for your needs. Rolling an old 401k into an IRA will help you get access to investments that may be more suitable for you than the investments offered in your 401k plan.

To transition, IRA rollovers also have disadvantages that you should be aware of. First off, you will not get an employer match when you contribute to an IRA. This is sort of a 'no duh' point, but it is something to keep in mind if you are thinking about rolling your old 401k into an IRA.

Secondly, IRAs have lower contribution limits than 401k plans. For 2024, the maximum amount you can contribute to an IRA is $7,000 per year or $8,000 per year if you are 50 or older. Rolling to a new 401k on the other hand would allow you to contribute $23,000 per year or $30,000 per year if you are 50 or older into that new account.

If you are a high income earner that can put a larger sum towards retirement, rolling your funds to an IRA alone may not be as viable as rolling to a 401k due to the amount you can contribute to the account. Instead, you can consider using both an IRA and a 401k.  

At this point, you should have a better understanding of the advantages and disadvantages of both a 401k and IRA rollover. However, you still may be wondering which one is best? Well, here's the good news. You do not have to choose between an IRA rollover or 401k rollover as you can have both accounts at the same time.

In personal finance, every single account, product, solution and piece of advice has pros and cons. The goal when you make a financial decision is to maximize the benefits of that solution and minimize the drawbacks. In doing so, your financial life will get better.

As discussed previously, the advantages to a 401k rollover are the potential for an employer match, the high contribution limits and automated contributions. However, you typically do not have as much control over a 401k when compared to an IRA and the investment selection is smaller than an IRA.

An IRA rollover on the other hand will give you more control over the account and increase the available investments. However, the contribution limits are lower and you will not get an employer match. Let's walk through an example that can help further explain the potential benefits of having both an IRA and 401k.

Jim is 35 years old and plans to retire when he is 65. He works as an engineer and makes $125,000 per year. Saving for retirement is important to Jim and his goal is to invest 15% of his income for retirement. For him, this would be $18,750 per year.

Jim has been working as an engineer for the past 13 years for the same company where he consistently participated in his 401k plan. Over those 13 years, he was able to build up his 401k account to $100,000. He has since left this company for a new job.

His new employer does offer a 401k plan, but he is unsure if he should roll his old 401k account to his new one or roll it to an IRA. There are going to be multiple factors that go into his decision so let's break it down by each option to see what a good solution would be for him.

Since Jim has always contributed to his 401k, he thinks it might be a good idea to continue to do so with his new employer. However, there are a couple of things that Jim does not like about this new plan. First, the employer match is 4% at his new plan whereas it was 5% with his old 401k plan.  

Additionally, his new plan has a two year vesting schedule for his employer match. This simply means that any matching contributions from his employer will not be his until he has been employed for at least two years.

Secondly, his new 401k plan only offers 15 mutual funds to invest in. Jim does not love all of the investments offered as many of them have high fees that will eat away at his returns. In spite of these drawbacks, Jim still plans to contribute enough to his new 401k to get his employer match, but also considers the possibility of rolling his old 401k balance to an IRA.

Remember, Jim has $100,000 in his old 401k plan. The first benefit that Jim would receive if he rolled these funds to an IRA is an increase in control. His IRA would follow him no matter where he worked and all of the money that went into the account would be his.

He may also have less restrictions on the types of withdrawals he can take from the account. Additionally, he would get access to a much larger investment selection. We know that Jim is not happy with the investment selection in his new 401k plan so having access to more investments through an IRA may be a viable solution for him.

With these factors in mind, Jim decides to roll his entire $100,000 balance from his old 401k plan into an IRA for the benefits discussed above. However, the rollover is not his entire retirement plan. Remember, Jim's goal is to invest $18,750 per year.

He decides that he will contribute enough to his new 401k plan to get his employer's 4% match. Since Jim makes $125,000 per year he will contribute $5,000 per year and get a match of $5,000 from his employer. After that, Jim decides to contribute the maximum amount to his IRA which is $7,000 per year in 2024.

This leaves Jim with $1,750 left to invest. He may decide to throw this money into his 401k or look to invest in other accounts or investments. The point of this hypothetical illustration is to help explain that you can use a 401k and IRA in tandem.

When you have an old 401k, it might make sense to roll all of it to a new 401k plan or IRA, or split the money between the two accounts. The goal is to maximize the benefits that each rollover option offers while reducing the drawbacks.

Something to keep in mind when considering a 401k or IRA rollover from an old 401k plan is the type of 401k account you have. In general, there are two options. First is the Traditional 401k, which is the more common of the two 401k types.

Traditional 401k plans offer a tax deferred benefit. In other words, you do not have to pay taxes up front on the money you contribute to the account as it is taken out of your paycheck pre-tax. However, when you retire you will have to pay applicable income taxes.

Roth 401k plans on the other hand offer a tax free benefit. You pay money on the contributions that you make to the account up front, but then do not owe taxes on the money when you retire. You may have already been aware of these differences, but they are worth mentioning in regards to rollovers.

As a general rule, most investors typically roll their old 401k plan to a new 401k or IRA with the same tax treatment. For example, say that your old 401k plan is a Traditional 401k. If you wanted to roll to an IRA, most of the time you would roll to a Traditional IRA.

If you were to roll a Traditional 401k to a Roth IRA, you would have to pay applicable taxes as you are going from a tax deferred account to a tax free account. On the flipside, you would typically roll a Roth 401k into a Roth IRA.

Keep in mind that this is an oversimplification. There may be circumstances that would justify going from a Traditional to Roth account or vice versa. Working with a financial advisor can be a viable option if you need a greater degree of help with this particular issue.

It is also worth noting that the tax implications of rollovers can be complex especially if you are rolling to an account with a different type of tax treatment. Working with a tax professional is a good idea to help ensure you understand the tax implications of a 401k or IRA rollover.  

The first step to roll funds from your old 401k is to open an account. This is typically only applicable to IRAs. If you already have an IRA, you can skip this step. But if you don't you can open one through an online broker. Your new employer will help you get access to a new 401k plan if you plan to do a 401k rollover.  

Secondly, you will need to contact your plan record keeper to request a rollover. If you are unsure of who your old plan record keeper is, you can look at your account statements or speak to your human resources department at your old company.

Your record keeper will need to know what financial institution the rollover is going to, as well as an applicable account number if necessary. Be prepared to provide this information to your record keeper to ensure your money goes to the right place.  

Once your record keeper has processed your requested transaction, it is also important to understand if you will get your money via a direct or an indirect rollover. A direct rollover is when the record keeper sends you a physical check to your address that is made payable to the financial institution that you are rolling funds to.

For example, say you had an old 401k plan in which Fidelity was your record keeper. If you wanted to roll your old 401k to an IRA at Charles Schwab, Fidelity would sell the assets in your 401k and write a check to Charles Schwab that says FBO (for the benefit of) you.

Since this check is made payable to Charles Schwab, you are not allowed to cash it. Instead, you will simply send it to Charles Schwab who will deposit it into the IRA you opened. Also keep in mind that direct rollovers can sometimes be completed via ACH transaction depending upon the financial institution.

An indirect rollover is where the check is made payable to you. Due to this, 401k record keepers are required by the IRS to withhold 20% of an indirect rollover for taxes. Once you get the check, you deposit it in your bank account and then deposit it into your new 401k or IRA.

You have 60 days to complete an indirect rollover. If you fail to deposit the money into your new 401k or IRA within that time, you can incur additional taxes on top of the mandatory withholding. The money that is withheld for taxes is returned as a tax credit for the year in which the rollover happened.

There are some circumstances in which an indirect rollover can make sense. However, most of the time a direct rollover is a better way to go. Your money will not be subject to a mandatory tax withholding and the process is less complex than an indirect rollover.

The bottom line is that rolling your old 401k to a new 401k or IRA both have pros and cons. Having both a 401k and IRA may also be a viable solution for you. At the end of the day, you have to pick the account that you believe will best help you reach your goals.