Workplace retirement plans—like the 401k—provide a great option for accumulating wealth while working. Having payroll deductions makes saving automatic and easy. Plus, employers often provide a matching contribution. However, when you leave a job that offered a 401k, you have freedom and flexibility with the money you’ve saved.
Compared with a workplace retirement plan like a 401k, an IRA is an Individual Retirement Account. This means that your IRA is not connected with your employer. A popular option for people with an old 401k is to transfer money from the 401k to their own IRA. This is called a rollover.
Have an old 401k? Here are four reasons to consider a rollover.
Investment options in your 401k can be hit-or-miss. Some 401k’s offer a robust investment menu, while others only have proprietary, high-cost funds that change from year-to-year based on recent fund performance. Having freedom and flexibility with your money means you can have a targeted investment strategy in your IRA. Whether you want to pursue a high-growth strategy, a diversified index portfolio, or a global dividend strategy, you now can tailor your investments to your financial plan and risk tolerance. You can also bypass the conflicts of interest that are present when 401k providers fill the investment menu with their own mutual funds.
If you have pre-tax money in your 401k, you are continuing to prolong the road of paying taxes on that money. Meanwhile, the money in your 401k should keep growing, ensuring a large future nest-egg of taxable funds. However, if you are currently in a low tax bracket, it might be beneficial to convert some or all of this money into a Roth IRA. Money in a Roth IRA is post-tax and grows tax free, meaning you won’t pay taxes on your future nest egg. The first step to a Roth conversion is to do a rollover of your 401k to a Traditional IRA. Once the rollover is complete, you can convert any amount to a Roth IRA. Interested in learning more about Roth conversions? Read our blog.
If you are retired, a 401k may not offer the best avenue for regular withdrawals. Many times, the 401k provider charges a fee for processing a distribution. Many IRA providers, like companies that offer brokerage accounts, make withdrawing your money a simple process. Systematic withdrawals can be setup to provide for a supplement to your social security and pension income.
If your beneficiary is someone other than your spouse, the IRS has mandated that the beneficiary must withdraw the retirement account and pay taxes on the money. However, the IRS also allows for the beneficiary to “stretch” those withdrawals over their life expectancy (by requiring a certain amount be distributed every year). If the money is in a 401k, the plan might not allow for this beneficial “stretch” withdrawal, but might require a strict distribution over five years. IRA’s do not have this restriction. Non-spouse beneficiaries of an IRA can distribute the funds over their lifetime, thereby minimizing taxes and allowing the account balance to potentially grow.
Knowing what to do with your investments can take time. If you have questions, we’d love to speak with you about them to help you plan the best solutions for your future. Give us a call today or fill out the form below!
Jake is a co-founder and Director of Investing at Stewardship Financial. In his role he gets to help people make smarter decisions on how to invest in the capital markets.