Pros and Cons of Rolling Your 401k into an IRA: A Comprehensive Guide

As someone who recently retired at 55, I have decided to leave at least half of my retirement funds in my old 401k, ensuring it remains protected from creditors while I can withdraw from it using the rule of 55.

The Pros and Cons Explained

One of the potential drawbacks of staying within a 401k is the presence of a fiduciary financial advisor assigned to the plan, who provides professional guidance while I am part of the plan. However, after leaving my employer, rolling over to an IRA offers several advantages:

Cost and Investment Flexibility

IRAs are almost always cheaper than 401ks for annual fees, making it a more economical choice. Furthermore, you have access to a wider range of investment options, not limited to those offered by your former employer. This includes the ability to choose from any fund or investment available on US and even foreign exchanges.

For those in a Traditional pretax 401k, the possibility of moving to a Roth IRA by rolling it over to an IRA is a significant benefit. However, this decision depends on your individual situation and should be handled with caution. The advantages and disadvantages of converting to a Roth IRA may vary, so thorough research is essential.

Flexibility and Protection

The most notable differences include the freedom to choose any financial institution for your IRA and the broad range of fund options it provides. Additionally, your former employer can change the 401k plan or move it to another institution, with the possibility of transferring it to a different type of plan with varying fund options. Should this occur, you would still have the opportunity to roll over to an IRA, though it could be challenging if the transfer is rushed.

Another key consideration is the withdrawal age. You can start withdrawing from your 401k at age 55 instead of 59 1/2 if you stop working. 401ks may require spousal approval for changes and offer more protection against creditors than IRAs. However, a Roth 401k will have Required Minimum Distributions (RMDs), while a Roth IRA does not. If you roll to a traditional IRA, you can convert some or all of it to a Roth IRA with taxes due in the year of conversion.

Conclusion and Practice

There is no inherent tax difference between a 401k and an IRA. The main motivation for rolling over should be the expansion of investment options, as IRAs generally provide more flexibility.

Whenever you leave a job, it is a good practice to roll your 401k into an IRA. This ensures you have complete control over your funds and can invest in a wider range of opportunities. In an IRA, you can sidestep the complications of managing funds within a 401k and have more options for further growth and diversification.