When you leave a job, you’re not only leaving your desk, co-workers and old responsibilities behind—oftentimes you’re leaving something else of high value. We’re talking about your 401(k). And when you leave behind your 401(k), you often become less involved with it. That means you probably won’t be as informed about plan, investment or expense changes, or worse, you may forget who the 401(k) provider is and your employer is no longer even around to help you track it down. And the longer you’re away from your old company, the more removed you are from these important facets of managing the retirement money you’ve worked so hard to save.
While much of the industry is focused on getting you to roll your old 401(k) into an IRA, and many of us have, is that the best thing?
Let’s consider some the pros and cons so you can make the best decision for you.
The Pros of Rolling IRAs and Old 401(K)S to Your Active 401(K) Account
1. One Account Is So Much Easier to Manage and Simplifies Your Money Management
When you have multiple retirement accounts, you have several logins to remember and phone numbers to call if you need help, and all of your important info is in various places. Managing how you have your money invested in stocks and bonds becomes cumbersome across accounts and can make it difficult to do well. By consolidating your accounts into just one 401(k), you’ll see your retirement savings in one place at a quick glance with one login and phone number to call. And yes, it makes managing your asset allocation easier than ever, as opposed to trying to do it across multiple providers and accounts.
2. Some 401(k) Plans Offer Low-Cost Investments
Consolidating your retirement accounts into a 401(k) account that implements an index fund solution and/or has access to institutional funds will likely also help keep your investment costs lower—and every dollar paid in investment expenses is one less dollar invested in the markets. In fact, paying just 1% more in fund and investment expenses can cost you hundreds of thousands in savings over a 40-year career. An index fund is a type of hands-off ETF or mutual fund that tracks a particular benchmark financial index, such as the S&P 500, Nasdaq or the Down Jones Industrial Average. In fact, it’s designed to mimic the performance of these market indexes. It’s a passive way to invest—and it’s this passivity that help give them a cost advantage over actively managed funds. Plus, index funds have historically outperformed actively managed funds. While there are no guarantees about the future, across major asset categories, the benchmark indexes have historically beaten 78% to 97% of actively managed mutual funds over a ten-year period of time. Do know that some 401(k) plans offer more expensive fund options, and therefore, these would not offer a cost advantage for you. If you see most fund expense ratios are over 1% in your 401(k), you can roll into an IRA and select lower expense index funds on your own.
3. Your 401(k) Money Is Protected from Creditors and Bankruptcy
The money you have in your 401(k)s has protections against creditors that IRAs don’t provide, including in bankruptcy, as well as against claims from creditors. IRAs are protected in bankruptcy up to a limit of $1,362,800 across all plans based on a government calculation. However, protections may vary from state to state.
4. Access to Your Money Via a 401(k) Loan in Case of Emergency
While you should look at this only as an emergency option, many companies allow loans in their 401(k) plan. If yours does, you can receive a loan for half your vested balance up to the $50,000 limit and then pay yourself back into your 401(k). Note that this will likely hurt your nest egg and if you lose or switch employers, the outstanding balance is typically due quickly and you could be stuck with a tax penalty if you are under 59 ½ years of age.
5. You Can Put Off Distributions Longer If You Work Past 72 Years of Age
With the SECURE ACT of 2020, a traditional IRA requires minimum distributions to begin at age 72. So does a 401(k). However, if you’re still working, you can postpone distributions from a 401(k) until you retire which can be well past the age of 72.
The Cons, Or Why You May Prefer to Roll an Old 401(k) into an IRA
Sometimes, rolling your old 401(k) into an IRA instead of an active 401(k) can make more sense for you. Yes, you’ll have an extra an account to manage, but costs and other consideration might make this the right call.
1. More, Better or Preferred Investment Options
Most 401(k) plans keep a set line-up of funds, model portfolios and/or target date funds. This can be a good thing as 401(k)s are focused on retirement appropriate investments. Yet, if your current 401(k)'s line-up is lacking for some important needs you have, or if you’re a more seasoned investor and are comfortable investing on your own, many IRA providers will enable you to invest as you choose in individual stocks, as well as other equity and bond funds and more.
2. Your 401(k) Has High Expense Fund Options
While we'd like to think most 401(k)s have cost advantages over an IRA, some just don't. Your 401(k) may not offer low-expense index or other low-cost fund options. As mentioned previously, if most of the fund expense ratios are over 1% in your 401(k)’s investment offering, you can find lower expense funds via an IRA.
No matter what, keep track of your money. That's typically easier to manage in one or two retirement accounts, so don’t leave that old 401(k) behind. Take the time to move it into your current 401(k) or an IRA so you can best manage it, keep costs low, and build up the best nest egg possible for yourself.