Benefits of Rolling Your Old 401(k) into a Rollover IRA

Here's Why You Should Consider an IRA Rollover When You Leave Your Job

Explaining his options regarding the deal
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Imagine that as the retirement planner you are, you've been participating in your employer-sponsored retirement plan like a 401(k) since you started work and you have been consistently making contributions from every paycheck. But perhaps one day you find another opportunity with another employer you can't refuse or you've been laid off.

What happens to the money that is in your former employer's 401(k) plan?

Well, luckily, all of the money you've contributed is still yours. If you were eligible for an employer match in your retirement plan, you may have rights to your employer's contributions depending on your vesting schedule.

It can be reassuring to know that you still have access to your contributions and those vested employer matching contributions. But what can you do with that money that's still in your employer's retirement plan once you leave your old company? You actually have several options to consider.

Your Employer Retirement Account Options

Whenever you after participating in a workplace retirement plan, you will have several options for what to do with the vested amount in that account. In fact, there are four options you should consider:

  1. Cash Out of the Plan
  2. Leave the Money in the Plan
  3. Rollover into Your New Employer's Qualified Plan
  4. Rollover to an IRA 

Cashing out of your former employer's retirement plan is almost never advisable. In fact, cashing out of your 401(k) is one of our top 6 retirement planning mistakes that you should avoid. Though leaving your money in your former employer's plan or rolling it over to a new employer plan are both fine options, don't disregard the opportunity to roll your funds into a rollover IRA. A rollover IRA comes with its own set of strategic benefits and when executed properly, ensures that you don't trigger any negative tax consequences.

What is a Rollover IRA?

A rollover IRA is identical to a Traditional IRA (or Roth IRA in the case of a rolling over Roth 401(k) funds) except that the source of the money is not annual contributions.

Instead, the money that goes into a rollover IRA is money from a previous retirement plan, such as a 401(k) plan. If you do not already have an IRA, you may open one for the purpose of rolling over your 401(k) funds without making any additional annual contributions (though you should!). On the other hand, if you do have an IRA, you are permitted to rollover your 401(k) into that existing contributory IRA account.

It is important to note, however, that you may not combine traditional IRA and 401(k) funds with Roth IRA and Roth 401(k) funds.

Benefits of Rollover IRAs

Many people overlook their rollover IRA option because they are just as happy continuing to keep their retirement funds in some form of employer plan, but there are a few compelling reasons why you may want to opt for the rollover IRA anyway.

IRA Rollover Benefit 1: Continued Tax Deferral

One big advantage of an IRA rollover is the continuation of the tax-deferred treatment you had at your workplace retirement account. Furthermore, no tax is owed on a properly executed rollover, although it is reportable transaction to the IRS.

IRA Rollover Benefit 2: Increased Investment Options

Within a 401(k) plan, your investment options are limited to the choices provided to you by your plan custodian and your employer. Often, these choices are sufficient, but rarely are they extensive. But with a rollover IRA, you can choose to put your money in virtually any mainstream investment imaginable.

IRA Rollover Benefit 3: Lower Fees

In addition to limited investment options, some employer-sponsored 401(k) plans are generally wrought with high administrative fees. These fees are not enough to make contributing to the plan a bad deal, but if you can keep those retirement assets growing in a similarly tax-advantaged option with lower fees, why wouldn't you? IRAs tend to have lower fees, if any, depending on where you open the account (such as a banking institution, with a financial advisor, or an online bank). 

IRA Rollover Benefit 4: Simplification

Instead of juggling a number of former workplace retirement accounts as you switch jobs over the course your career, consistently rolling over your plans to a single rollover IRA reduces complexity. You can look at one account statement and see the balance, recent performance, and investment selections of most of your retirement savings from one account.