If youve left a previous job and decided what to do with the money in your former employers retirement plan, take a moment to feel proud. There are many complex factors to consider so giving the decision time and consideration is important.
If youre still on the fence about what to do with your old 401(k), 403(b), or any other workplace plan, dont be hard on yourself. We all get busy. But it is important to make a mindful selection when youre ready. You generally have 4 choices:
Its important to know that some plans may have a provision that requires rolling over balances under a certain threshold to an IRA established on your behalf. Balances under $1,000 may be distributed by check. You will get 30 days notice though, so you can make your own plans for your money.
If youve concluded that rolling the money into an IRA is for you, youll need to get the ball rolling. Start by contacting your former plan to let them know youd like to roll your funds to an IRA. Ask them what the process and requirements are so you can prepare.
“Youre in the drivers seat,” says Sham Ganglani, Fidelity Investments director of retirement product management. “Its important to make a decision about where you would like your money to go.” That could be especially true if youve been advised that it will be rolled over to an IRA chosen for you by your former employers plan or cashed out due to minimum, or de minimis, limits as theyre called.
Below are 4 common—and avoidable—pitfalls that can occur while transitioning a former employers retirement plan into an IRA. Because rolling over a retirement account can be such an important decision, it can make sense to talk to a tax or financial professional if youre unsure about your next steps.
Have you ever left a job and wondered what to do with your 401(k)? The conventional wisdom often pushes you toward rolling that money into an Individual Retirement Account (IRA). While this might be the right move for many folks, I’ve discovered there are some significant drawbacks that financial advisors don’t always mention upfront
Before you make a decision that could impact your retirement for decades, let’s take an honest look at why keeping your money in your employer’s 401(k) plan might actually be the smarter choice in certain situations
The Hidden Disadvantages of Rolling Over Your 401(k)
1. You Could Be Giving Up Greater Buying Power
One of the biggest advantages of large company 401(k) plans is their ability to access institutional-class funds at discounted rates Think of it as a corporate discount that individual investors simply can’t get.
As Wayne Bogosian, former president of the PFE Group explains, “Most 401(k), 403(b), and 457 plans have significant buying power—much more than the individual retirement account.” This buying power can result in substantially lower fees, which means more money staying in your account and growing over time.
When you roll over to an IRA, you might end up paying higher expense ratios for similar funds. While the average expense ratio in retirement plans is around 0.68% for stock funds and 0.54% for bond funds according to the Investment Company Institute, retail investors in IRAs often pay more.
2. You’ll Lose Potential Tax Advantages with Company Stock
If your 401(k) includes appreciated company stock, rolling over to an IRA could cost you big time in taxes.
Here’s how it works: When you transfer company stock from your 401(k) to a regular brokerage account (not an IRA), you’ll pay ordinary income tax only on the original purchase price of the stock. Any appreciation in the stock’s value won’t be taxed until you actually sell it—and even then, it will be taxed at the lower long-term capital gains rate. This strategy is called Net Unrealized Appreciation (NUA).
Let me show you with an example:
Suppose you bought company stock for $10,000, and now it’s worth $50,000. If you use the NUA strategy:
- You’ll pay income tax now only on the $10,000 basis
- The $40,000 in appreciation will be taxed at the lower capital gains rate when you sell
If you roll that stock into an IRA instead, you’ll eventually pay your higher ordinary income tax rate on ALL of it when you take distributions. Ouch!
As Jonathan Swanburg, a CFP in Texas, puts it: “NUA is a tremendous opportunity for individuals with appreciated company stock in their 401(k).”
3. You’ll Have Less Legal Protection from Creditors
This is a big one that most people don’t think about until it’s too late. Your 401(k) has excellent legal protection from creditors under federal law (ERISA).
If someone sues you and wins a judgment, they generally can’t touch your 401(k) assets. IRAs, however, don’t have the same level of protection. While IRAs are protected in bankruptcy under federal law (up to about $1 million), protection against other types of judgments varies widely depending on which state you live in.
For doctors, business owners, or anyone at higher risk of lawsuits, this difference in creditor protection could be crucial. As Daniel Galli, a CFP in Massachusetts, notes: “For physicians, protecting retirement savings from creditors is a very big issue.”
4. You’ll Lose Access to Early Retirement Benefits
Here’s something that could really matter if you’re planning to retire early: 401(k) plans allow penalty-free withdrawals if you leave your job in or after the year you turn 55. With an IRA, you generally have to wait until age 59½ to avoid the 10% early withdrawal penalty.
As Marguerita Cheng, a CFP, explains: “One of the most important reasons not to roll over your 401(k) to an IRA is to have access to your funds before age 59½. They can be accessed as early as age 55, versus having to pay a 10% early withdrawal penalty in an IRA.”
This 4½ year difference could be critical if you’re planning an early retirement!
There’s also a flip side for those working later in life. If you’re still employed at age 70½, you don’t have to take Required Minimum Distributions (RMDs) from your current employer’s 401(k) plan. But with an IRA, you must start taking distributions at 73 regardless of employment status.
5. You’ll Miss Out on Stable Value Funds
Company 401(k) plans often offer access to stable value funds, which are low-risk investment options that typically provide better returns than money market funds. These special funds are ONLY available in employer-sponsored retirement plans—you simply can’t get them in an IRA.
With recent yields averaging around 1.8%, stable value funds can be an attractive alternative to money market funds for conservative investors. Plus, unlike bond funds, they won’t get crushed if interest rates rise.
Common Rollover Pitfalls to Avoid
If you do decide to roll over your 401(k) to an IRA, watch out for these common mistakes:
Not Rolling Into the Right Type of IRA
Make sure you match your rollover to the right type of account. If you have pre-tax money in your 401(k), it should go to a traditional IRA. If you have a Roth 401(k), it should go to a Roth IRA.
As Sham Ganglani, Fidelity’s director of retirement product management, says: “You’re in the driver’s seat. It’s important to make a decision about where you would like your money to go.”
Getting a Check Made Out to You
The IRS has specific rules about how rollovers work. If your old plan sends you a check made out to you personally (rather than directly to your new IRA provider), they’ll withhold 20% for federal taxes.
To avoid this headache, request a “direct rollover” where the check is made payable to your new IRA provider for your benefit (usually written as “FBO” followed by your name).
If you do receive a check, you’ll need to deposit the entire original amount (including the 20% that was withheld) into your IRA within 60 days to avoid taxes and penalties. That means you’ll need to make up the withheld amount out of your own pocket!
Letting Your Rollover Stall
Don’t assume everything is going smoothly with your rollover. “The transfer can stall for any number of reasons,” warns Ganglani, so it’s vital to “proactively follow up.”
If the rollover hasn’t arrived in your IRA within the expected timeframe, call your former employer’s plan provider to check on the status.
Forgetting to Invest Your Rollover Money
“Your rollover is not done until you invest your money,” says Ganglani.
Unlike 401(k) plans, investments aren’t automatically made when money moves into an IRA. You need to actively choose investments. Otherwise, your retirement savings could sit in cash for years, missing out on potential growth.
As Scott Boyd, a regional investment consultant at Fidelity Investments, points out: “If you’re 30 or 40 years old, it can sit there as cash for the next 20 to 30 years or so, until you’re ready to retire. That’s a big, missed opportunity for growth potential over that period.”
What Should You Do With Your 401(k)?
Remember, you generally have four options when you leave your job:
- Keep the money in your former employer’s plan
- Roll it over to an IRA
- Roll it to your new employer’s plan (if allowed)
- Cash out (rarely advisable due to taxes and penalties)
Before making a decision, check your current plan’s rules and fees. Most employers require you to maintain a minimum balance if you want to leave your account in place after you leave.
Also, check if your plan allows regular withdrawals in retirement. About two-thirds of large 401(k) plans let retirees take scheduled withdrawals, but others have an “all or nothing” requirement.
The Bottom Line
While rolling over to an IRA gives you more investment choices and control, it’s not always the best move. For many people, keeping money in a 401(k) makes more sense, especially if your plan has low fees, you own appreciated company stock, you’re concerned about legal protection, you plan to retire early, or you value stable value funds.
As Daniel Galli wisely advises: “It seems like everybody and their brother is interested in rolling money out of your 401(k). But there’s no downside to leaving your money in your former employer’s plan while you consider your options.”
So take your time, weigh all the factors, and make the choice that’s best for YOUR specific situation. Your future retired self will thank you!
Have you ever kept your 401(k) with a former employer instead of rolling it over? I’d love to hear your experiences in the comments below!
Pitfall #1: Not rolling into the right IRA
Once youve decided to roll the money into an IRA, there are a few steps to take and some planning steps to think about. For instance, do you only have pre-tax money with your former employer, a combination of pre- and after-tax money, or only after-tax money?
How to avoid this pitfall:
If you dont already have an IRA at the receiving institution, make sure you open the right IRA based on the type of contributions made to your former plan.
A rollover IRA is a retirement account that allows you to move money from your former employer-sponsored plan to an IRA—tax- and penalty-free1—while keeping your moneys tax-deferred status.
Rollover IRAs are generally meant for pre-tax money from a workplace retirement plan. If your former plan was a Roth 401(k), a Roth IRA is an appropriate choice.
Ask your IRA provider for help choosing the right account if youre unsure. They can explain the options available to help you decide.
Less common, if youve made after-tax contributions to your 401(k), not Roth contributions, it can be a good idea to speak with a financial professional or research what to do with after-tax 401(k) contributions.
Once you have your account(s) open and ready to go, contact your former plan to start the rollover.
If you need assistance, dont hesitate to call and ask for help. A representative from your new firm may be able to join a phone call with the previous firm. If you need help rolling over your old 401(k) to a Fidelity IRA, call 800-343-3548. Generally the entire process can be completed online but help is available.
Have ready the account number for the new account, the official name of the institution where the money is to be rolled over, wire instructions, or the address where the money should be sent when you start the rollover.
Pitfall #3: The rollover stalls for some reason and you don’t realize it
“The transfer can stall for any number of reasons,” says Ganglani, so its vital to “proactively follow up.”
You dont want to lose track of where your money is—still in the old plan in this case.
How to avoid this pitfall: Be sure to follow up. When you initiate the rollover, confirm the requirements with your former employers plan provider and ask for the average amount of time to process a rollover request. If the rollover hasnt arrived in your IRA near the expected time, call the employers plan provider and ask about the status.
You can leverage your IRA provider to make this call. Calling your former plan with a representative from your IRA provider can make the conversation easier. If theres something holding up your rollover, you and the IRA representative can get to the bottom of how to get past the issue and complete your rollover.
401k to IRA Rollover Pros and Cons
FAQ
What are the disadvantages of rolling over a 401(k) into an IRA?
What Are the Disadvantages of Rolling Over a 401 (k) Into an IRA? Some of the disadvantages of rolling over a 401 (k) into an IRA include no loan options, a decrease in creditor protection, possibly higher fees, and the loss of a possible earlier withdrawal without penalty.
What happens if you roll over a 401(k) into a Roth IRA?
If you roll over a traditional 401 (k) into a Roth IRA, there will be tax consequences. This is because a traditional 401 (k) is funded with pre-tax dollars while a Roth IRA is funded with after-tax dollars. 12 What Are the Disadvantages of Rolling Over a 401 (k) Into an IRA?
Do you lose money if you roll over a 401(k)?
You won’t be penalized by rolling over a 401 (k), but you will be penalized if you withdraw from a 401 (k) early without an exception. You won’t be taxed on a 401 (k) rollover unless you roll your account into another account with different tax treatment. You do not lose money by rolling over a 401 (k).
Can a 401(k) be rolled over to an IRA?
Your current employer may allow you to leave it where it is, or you can roll it over into your new company’s employer-sponsored 401 (k). Or you can skip employer-sponsored plans altogether and roll over the money into an individual retirement account (IRA).
Should I move my old 401(k) to an IRA?
Your old 401 (k) has no glaring issues. Specifically, this means that your 401 (k) plan (from a previous employer, as you’re not able to roll a current 401 (k) into an IRA) charges no excess fees and offers a low-cost investment menu. If your old 401 (k) is no better off in an IRA than in its current state, there’s no real reason to move it.
Should I roll over my 401(k) in bankruptcy?
Not rolling over your 401 (k) can help with legal protection in bankruptcy and provide access to your money at an earlier age, if you qualify for an exception. Company 401 (k) plans have access to stable value funds. 1. Greater Buying Power Company 401 (k)s can purchase funds at institutional pricing rates, which is not usually true for IRAs.
Where is the safest place to put a 401k after retirement?
The safest place to put your retirement funds is in low-risk investments and savings options with guaranteed growth. Low-risk investments and savings options include fixed annuities, savings accounts, CDs, treasury securities, and money market accounts. Of these, fixed annuities usually provide the best interest rates.
Is it better to rollover a 401k or leave it?
The Bottom Line: Since your 401k dollars are already invested, it makes sense to keep them invested and immediately drop them into index funds as soon as the rollover is complete. Even in a scenario where we’re talking about fresh dollars being invested, lump sum investing is still the best move.
What does Warren Buffett say about 401k?
For investors with 401(k)s or traditional IRAs, this approach suggests the importance of managing risk by diversifying into safer assets like bonds, real estate, or precious metals, especially during periods of market uncertainty. Diversification: As Buffett’s actions show, it’s crucial to diversify your portfolio.
Can I transfer my 401k to an IRA without penalty?
