One question I’m asked regularly–presumably because of the high turnover in our economy–is whether it’s better to roll an old 401(k) account into an IRA or into the 401(k) plan at your new job.
Typically, the benefits packet you receive when you’re hired will encourage you to rollover your prior 401(k) into your new 401(k). The ugly truth is that this recommendation has nothing to do with your interests and everything to do with the plan administrator’s interests. (They’re paid a percentage of assets under management.)
What You Should Do Instead
In almost every case, the answer is that you should roll your 401(k) account into an IRA. By doing so, you can:
- Reduce your administrative costs. (Many brokerage firms charge no administrative fees for an IRA, whereas most 401(k) plans charge admin fees in the range of 0.5% to 1% per year.)
- Reduce your investment costs (by using low-cost index funds or ETFs rather than the high-cost funds included in your 401k), and
- Achieve better diversification (because you’ll have access to a broader range of funds).
Related resource: How to Roll a 401(k) Account into an IRA
Possible Exceptions
In a few, fairly uncommon situations, it may make sense to either keep your old 401(k) where it is or roll it into your new 401(k). Specifically:
- You expect to retire between age 55 and age 59½,
- You expect to be sued in the near future, or
- Your old 401(k) includes employer stock that has significantly appreciated in value.
If you’re in one of the above situations, the way to choose between your old 401(k) and your new 401(k) is to compare the plans’ respective administrative costs and investment options (look for low-cost funds).
Related resource: Reasons Not to Rollover a 401(k)
Choosing an IRA
When it comes time to determine where to open your IRA, my suggestion is to compare costs for your particular situation. Depending upon the size of your rollover and the amount of time until you retire, it may make sense to open an account at a mutual fund company (and buy index funds) or to open an account at a discount brokerage firm (and buy ETFs).
Related resources: Where to Rollover My 401(k) and Comparison of IRA Costs at Discount Brokerage Firms
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Mike another good post. As a financial advisor I generally agree that I prefer to have a client roll their old 401(k) over to an IRA so we can take advantage of ETFs and other vehicles that would be available at the IRA custodian but not within their old 401(k). As you point out, however, this is not the right answer for all. As with much in my profession, the answer is “it depends.” Each investor’s situation is different and this decision should be based on the individual’s unique circumstances.
Mike,
Good article- I was most interested in the exceptions.
>You expect to retire between age 55 and age 59½,
I guess the required ages for withdrawal without penalties are different?
>You expect to be sued in the near future, or
Better legal protection for 401K?
>Your old 401(k) includes employer stock that has significantly appreciated in value.
Why is this exception? Is there some special tax consequence for appreciation of employer stock? If you transferred to an IRA you could still hold that stock or sell and buy something more diverse like an index fund to reduce risk.
-Rick
Hi Rick.
You’re exactly correct regarding the first two exceptions.
As to the reason it might make sense to keep appreciated employer stock in a 401k rather than rolling it into an IRA: the Net Unrealized Appreciation rules may allow you to roll it separately into a taxable account–and therefore sell it subject to LTCG tax rates rather than the ordinary income rates that apply to IRA distributions.
A little more info regarding all 3 exceptions can be found here.
Another reason *not* to roll – You have post-tax IRA money you can convert to Roth next year. By rolling the 401(k) to IRA, all IRA money is added up, and you’ll pay more tax on the Roth conversion. There is no keeping post-tax and pre-tax IRAs separate, it’s one IRA, with post tax component.
Thanks for summing this all up. I have a friend who hasn’t opened their IRA and hasn’t rolled over money from an old 401k account. I am sending them this post because they have been dragging their feel for 9 months now.
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