Should You Roll Over the Employer Retirement Plan from Your Former Employer into an IRA?
In many instances, people have changed jobs throughout their careers and need to decide what to do with their old 401(k) or 403(b) from their previous employer(s). Having many different accounts at different places and receiving numerous statements throughout the year can feel complicated, disorganized, and hard to keep track of. In many cases, rolling the money from your 401(k) or 403(b) to an IRA is the best move. Putting all your retirement savings in one place makes managing your accounts and monitoring your progress easier. For many, gaining clarity can be the major factor in choosing a rollover IRA.
Below is a summary of some factors to consider and the benefits of rolling over an employer retirement account rollover to an IRA account:
Improved (and increased) investment options Most employer retirement plans have a limited number of investment options you can choose within the plan. This can be especially so for many fixed-income (bond) categories of investments, which can be extremely important for people considering retirement or already retired. Rolling your money into an IRA can likely provide you with a broader range of better-performing fixed-income options. IRAs offer “open architecture,” meaning you can buy almost anything such as low-cost mutual funds or exchange-traded funds that may not be available to you in other retirement accounts.
Reduced fees and expenses Many employer plans charge participants some ongoing administrative or maintenance fee. These fees could be a percentage of your account value or a fixed dollar amount per year (these fees tend to be more prevalent in plans of smaller employers because small 401(k) plans have fewer investor dollars). Most major IRA custodians don’t charge fees to open or maintain IRAs. So, most IRAs have no ongoing administrative or maintenance fees. Also, in general, you will likely be able to reduce the management fees you pay for investments in an employer retirement plan by moving to an IRA account that will allow you to improve your ability to select from a broader range of improved (and lower cost) investment options that an IRA account can offer.
Other fees to consider with employer plans are the transactional fees. Some employer retirement plans may charge a fee whenever you take a distribution. In comparison, IRAs generally don’t charge any fee to take money out. So it can be cheaper to distributions out of an IRA instead of your employer retirement plan once you are retired and actively withdrawing funds.
Improved risk management Leaving numerous previous employer plans separated could result in an unintentional overlapping of funds that may not suit your age and tolerance for risk. Having your assets in one place can allow you to assess your overall asset mix better and make necessary changes over time across all of your investments. While having all of your investments in one place will not reduce your taxes, it could make your bookkeeping a lot easier (website logins and number of account statements) and prevent errors. It is worth noting that the penalty for an RMD that has been missed or not fully taken is 25% (and possibly 10% if the RMD is corrected within two years).
Better control over tax withholdings Most employer retirement plans have a mandatory 20% federal tax withholding that will be made when it comes time to take a distribution. This means that 20% will be withheld for federal taxes and sent straightaway to the US Department of Treasury on your behalf. If you effectively only owe 15% at tax time, you’ll have to wait until you file your taxes to get that 5% back. In many instances, it may be better to have more control over how much tax you withhold from your distributions. You can withhold as much or as little federal tax as you want in an IRA. That gives you more flexibility and control in managing how and when you have taxes withheld.
Less complicated and fewer Required Minimum Distributions (RMDs) to manage Both employer retirement plans and IRAs are subject to RMDs. When the account holder is of a certain age, the IRS requires the person to distribute – and pay tax on – a minimum amount each year. Each employer plan (thats not a SEP IRA or SIMPLE IRA) has its own RMD that must be met. For example, if you have retirement accounts with three 401(k) plans from the last three jobs you had, you will need to separately calculate and take an RMD from each of those three plans when you reach your RMD age. Alternatively, if you roll them all into an IRA, you have one RMD to calculate and take, making managing RMDs much easier. You can’t do that with non-IRA employer plans; they each need to independently satisfy their own RMD requirement.
Ability to do Qualified Charitable Distributions (QCDs) If you plan to contribute to charitable causes and are at least 70 ½ years old, the IRS will let you do a distribution of pre-tax money from your IRA directly to a qualified charitable organization or place of worship, etc. This is called a Qualified Charitable Distribution, or QCD. It can only be done from IRAs (or inherited IRAs), not employer plans. Donating via QCD instead of giving cash from your bank account is arguably the most tax-efficient way to make cash donations, and here’s why: If you take a normal distribution out of your IRA, that will increase your gross income. However, assume you then turn around and donate that cash to a charity. Assuming the donation is large enough to itemize as a deduction on your tax return, the donation will reduce your taxable income and offset the increase in gross income caused by the distribution. So, the tax impact is avoided because the itemized deduction of the donation reduces your income by the amount of the IRA distribution. The other main benefit of QCDs is that they can replace RMDs. If you’re charitably inclined, of RMD age, and don’t need the money from the RMDs, you can do QCDs to use up all or some of those RMDs, thus not having to realize them as taxable and keeping them off of your tax return. So, the QCDs will go directly to the charitable cause of your choice.
Easier conversion to a Roth account Many high-income earners who dont meet the Roth IRA rules for eligibility rules may want to do Roth conversions or back-door Roth IRAs to benefit from the tax-free growth this account offers. Roth conversions and Roth IRAs will require you to pay taxes when you convert pretax money. This process can be more straightforward using an IRA account as a starting point.
Conclusion
The correct choice as to whether or not you should move your old retirement plan will depend on your specific circumstances, facts, and goals. Moving your retirement plan can have significant financial implications. Rolling your 401(k) into an IRA can also have disadvantages. These can include less creditor protection (a creditor cannot seize your 401(k) assets), a reduced ability to take early withdrawals without penalty if you are 55 or older and are laid off, the loss of the right to delay RMDs if you are still working when your RMDs are scheduled to begin, and the loss of access to any loan options your 401(k) plan provided. Ultimately, the decision to roll over a 401(k) or 403(b) to an IRA should be based on the investment options and fees of your current plan, your investment strategy, and whether you value the flexibility and control offered by an IRA.
