The process of saving up for retirement, often done automatically through payroll deductions, is one that can easily retreat to the back of your mind. It’s important to take the time to periodically check your retirement savings plan to see if any adjustments are needed to better fit your circumstances and goals.
One of the simplest steps you can take: rolling over a 401(k) to an IRA, or individual retirement account.
In a 401(k), an employee makes pre-tax payroll deductions to an account sponsored by an employer, who may opt to match the employee’s contributions up to a certain point. If you leave your job for any reason, the employer’s contributions will stop and you will no longer be able to contribute to this account.
An IRA is managed independently, allowing you to contribute some of your income toward this account, take more control over your investments, and have a retirement account that may accept contributions, regardless of your employment status. The deductibility of an IRA contribution is phased out based on your income.
If you maintain both a 401(k) and an IRA, however, you are limited in what you can personally contribute each year. Individuals under 50 who have both types of retirement accounts can contribute up to $23,000 to a 401(k) and $7,000 to an IRA; individuals ages 50 and older can contribute up to $30,500 to a 401(k) and $8,000 to an IRA.
Should you create a single retirement account by rolling over a 401(k) to an IRA? Here are some scenarios where this option might be a good idea:
You’re leaving a previous job
Depending on how much you have invested in your 401(k), your employer may not hold on to your retirement assets for you when you leave a job. For sums of less than $1,000, they can simply cash out the account and send you a check — with the sum being taxed at federal and state levels. If your 401(k) has between $1,000 and $7,000, you will need to move the money to the retirement savings plan offered by your new employer or into an IRA.
When a 401(k) account has a balance above $5000, you have the option of leaving the funds with your previous employer. The drawback of this approach is that you’ll no longer be able to make contributions to the 401(k), which limits your potential investment gains. You’ll also continue to pay fees on the 401(k) account, and your previous employer may increase these fees once you’re no longer with the company.
By moving your 401(k) balance to an IRA, you can resume contributions to the principal balance of your retirement savings. This, in turn, can potentially yield higher returns from your portfolio. Many participants find that the variety of investment choices increases when they move the funds out of a company retirement plan.
For some 401(k) accounts, the rollover process can be more complex. For example, a 401(k) with a previous employer might have a substantial amount of the portfolio invested in the company’s stock, or you may only be partially vested in the plan and not yet able to receive the full employer match. A financial advisor can help you scrutinize these issues and plan the best path forward.
You want to consolidate retirement accounts
In today’s work environment, people are changing jobs more frequently as they search for career advancement opportunities, higher salaries, improved work-life balance, or a better corporate culture. This can lead to a person having several different 401(k)s with different plan types and asset allocations.
Rolling these 401(k)s into a single IRA offers a convenient way to manage all of your retirement assets. It eliminates the need to keep track of multiple different accounts, logins, investment options, and other information. Instead, you can manage one convenient portfolio that gives you a clear look at your retirement savings and helps you make informed decisions.
Keeping your retirement funding in a single IRA isn’t putting all of your eggs in one basket, as you’ll be able to diversify your portfolio to manage risk. This approach also eliminates a certain risk factor that comes with leaving multiple 401(k) accounts behind with other employers. You might simply forget about an account, or have more difficulty accessing it if a former employer goes out of business or changes plan administrators.
You’re looking for more investment options
The investment choices in a 401(k) are chosen by the employer sponsoring the plan, and typically offer a more constricted range of investments. Most 401(k) plans have a limited range of investment choices, and you may only be able to select from a handful of mutual fund options. Most plans offer Target Date funds as an alternative for investors who are unsure of what to select as an investment option.
IRAs offer more diverse investment options, including mutual funds, exchange-traded funds (ETFs), certificates of deposit, annuities, and real estate investment trusts (REITs). This broader range of choices allows you to build a more diversified portfolio that better aligns with your risk tolerance and retirement goals. For example, younger workers with a longer time horizon may opt for stocks that can potentially offer higher returns, while those seeking to maximize their cost efficiency may opt for investments like ETFs and index funds.
You want to be more flexible with your retirement strategy
While the investment decisions in 401(k) portfolio are made through your employer, IRAs give you complete control over your portfolio. This allows you to quickly and easily make changes to your portfolio as needed.
For example, life events such as the birth of a child, purchase of a home, or increase in salary can all impact how much you can budget for your retirement, and may change your risk tolerance as well. Working with a financial advisor, you can update your IRA to make adjustments that take your new circumstances into consideration.
IRAs can also offer better flexibility compared to 401(k)s in other areas as well. These portfolios generally have fewer restrictions when it comes to estate planning and choosing how funds will be distributed, and may offer more exceptions for penalty-free early withdrawals for purposes such as purchasing your first home or paying for higher education expenses.
You’re dissatisfied with 401k provider
If you are keeping a 401(k) with a previous employer but unhappy about how it is performing or being managed, a rollover to an IRA offers a quick and easy way to update your retirement plan. You might choose this option if your 401(k) has anemic gains or frequent losses.
Be aware that active employees typically cannot roll over their 401(k)s to an IRA unless there is an in-service distribution clause allowing it. This clause may also specify a certain age, such as 59.5 or 62, when a rollover is permitted.
The team at Grey Ledge Advisors can discuss the process of rolling over a 401(k) to an IRA and whether this option is a good way for you to achieve your retirement goals. Contact us today by filling out our online form or calling 203-453-9075.