How to Decide Whether to Roll Over a 401(k) to an IRA

401(k), Investing, IRA, Retirement Planning
Deciding Whether to Roll Over a 401(k) to an IRA

Many people benefit from turning a 401(k) into a rollover IRA after leaving a job, often in the form of lower fees, a larger investment selection or both. But it’s important to know the pros and cons before making this decision — after all, we’re talking about your retirement savings here.

Why should I roll over my 401(k) to an IRA?

An IRA offers several benefits over a 401(k), especially once you’ve left your job, which means you can no longer contribute to the account and you’re no longer earning an employer match.

  • No taxes or penalties: With a direct 401(k) rollover, taxes continue to be deferred until you withdraw money.
  • Wider investment selection: You get access to a range of investment options, including stocks, bonds, mutual funds, index funds and exchange-traded funds.
  • Maybe lower costs: An IRA provider offers a large selection of fund choices, so you can choose those with the lowest expense ratios.
  • No account fees: You can find an IRA provider that charges no fees to open or maintain an account. Many 401(k) plans charge participants administrative fees, though some generous employers pick up the tab. You can use our fee analyzer to find out more.
  • Low-cost options for investment management: You can open your IRA at a robo-advisor, a computer-run investment management company that charges less than 0.50% to manage your account for you.
  • More loopholes for early withdrawals: IRAs allow early distributions without penalty — but with taxes still owed — for certain expenses, like higher education and a first-time home purchase. The 10% tax on early withdrawals from a 401(k) is waived in only a few severe circumstances, like total disability or medical bills that exceed 10% of your adjusted gross income.

Why wouldn’t I want to roll over my 401(k) to an IRA?

There are a few scenarios that might make rolling over the wrong choice for you.

  • Limited creditor protection: 401(k)s are protected in bankruptcy and against claims from creditors. IRA protection from creditors varies by state, and bankruptcy protection is limited to $1.28 million.
  • Loss of access to loans: As noted above, it’s a bit harder to get at the money in a 401(k) before you retire. But many 401(k) providers do allow participants to take loans from the plan. You can’t take a loan from an IRA.
  • Required minimum distributions: 401(k)s and traditional IRAs require distributions beginning at age 70½. But a 401(k) has a loophole: It allows you to push off those distributions until you actually retire, even if you do so after 70½.
  • 401(k)s offer potential for earlier access: If you leave your job, you can tap your 401(k) as early as age 55. With an IRA, in most cases you can’t begin taking qualified distributions until age 59½.
  • Taxes on company stock: Company stock should generally be rolled over to a taxable brokerage account, not an IRA. If your 401(k) plan holds company stock, we recommend consulting a tax professional.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.