Two common terms you’ll hear when planning your retirement are 401(k) and IRA. A 401(k) is an employer-sponsored account that allows you to set aside a portion of your earnings for retirement. Many companies match part of your contributions as an employment benefit, which is a strong incentive to participate. On the other hand, an individual retirement account (IRA) is a personal savings plan. 

Moving money from a 401(k) to an IRA is called a rollover. This article will discuss the pros and cons of an IRA versus a 401(k) and how a 401(k) rollover to an IRA might benefit you. Another option, not discussed in this article, is moving your 401(k) to a new 401(k) if you continue to work and your new employeroffers that option.

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10 pros and cons of rolling over a 401(k) into an IRA

Like any investment strategy, moving money between retirement accounts has benefits and drawbacks.

Pros of rolling a 401(k) into an IRA

If you’re wondering what the advantages are of rolling over a 401(k) to an IRA, here are a few things to keep in mind.

1. More investment choices

Employers and their third-party 401(k) providers choose which products you can invest in. Often, options include a selection of preapproved mutual and exchange-traded funds. You can’t select assets outside of that list, and plans may limit the number of times you transfer between funds per year.

With an IRA, you can pick from thousands of investment options, including stocks, bonds, and annuities. And since you’re in control, you can move funds within investment options whenever you’d like.

2. Easier to get up-to-date information about changes

After leaving a job, it’s common to roll 401(k) funds into an IRA . You’re allowed to leave the account as-is, but employers usually communicate 401(k) changes directly to existing employees. They may not publicize this information or make it a priority to send it to you. So, you may not be up to date on where your investments stand. 

When your money is in an IRA, you control the funds directly. You can access your account, see updated information, and transfer money to different assets anytime.

3. Lower fees and costs

401(k) plans often include account maintenance fees, such as administrative, investment, and service costs. While employers might cover the admin charges, employees are usually responsible for investment and individual service fees. 

IRAs can also come with investment fees, but the key difference is control. With an IRA, you choose the financial institution and the specific investments, so you can shop around for low-cost or fee-free options. In contrast, 401(k) plans limit you to your employer’s chosen investments, which may come with higher or unavoidable fees.

4. Possible incentives such as cash or free stock trades

Some financial institutions offer bonuses or free stocks to encourage rollovers. For instance, TD Ameritrade, Charles Schwab, and Ally Bank all offer tiered rewards based on how much you deposit. While this shouldn’t be the only driving factor in your rollover decision, it’s a small way to increase your accounts’ value.

5. Fewer rules and barriers to entry

Employers have more flexibility when setting up 401(k) plans, which means the rules won’t necessarily be the same between companies. Further, they can put certain restrictions in place, like limiting participation to those with at least one year of service.

IRAs come with fewer limitations. You have more freedom to move your money, adjust your investments, and make decisions without employer-specific rules slowing you down.

Cons of rolling a 401(k) into an IRA

Although rollovers offer plenty of benefits, there are also disadvantages to weigh as well.

1. Greater buying power with a 401(k)

When you participate in a 401(k), your plan pools your assets with those of other employees, which often means institutional pricing. In other words, purchasing similar holdings in an IRA may cost you more. Additionally, your employer may match a percentage of your 401(k) contributions, which is a faster way to grow your retirement account.

2. 401(k) tax savings

If you plan on working past the normal retirement age, a 401(k) may be a better option from an income tax standpoint. When you invest in an IRA, the IRS makes you take withdrawals starting at age 73. These are called required minimum distributions (RMDs).

A 401(k) can delay RMDs until you want to retire if you’re still working for the employer who sponsors the plan and you don’t own more than 5% of the business. In this case, you won’t owe taxes until you start taking disbursements.

3. 401(k)s have better legal protection

With limited exceptions, the Employee Retirement Income Security Act protects 401(k)s from bankruptcy and lawsuits.

The Bankruptcy Abuse Prevention and Consumer Protection Act secures both Roth and traditional IRAs for up to $1,500,000 in bankruptcy proceedings. But safeguards for non-bankruptcy situations, such as divorce and lawsuits, vary by state.

4. Early retirement benefits (Rule of 55)

After 55, you can withdraw from your employer’s 401(k) without incurring the 10% IRS penalty. But taking out IRA funds before you’re 59½ will usually lead to early withdrawal penalties.

5. 401(k) stable value funds

Some 401(k)s offer stable value, low-interest, and low-risk cash funds. They protect your initial investment and are a safe way to grow your savings. IRA account holders don’t have access to these assets.

How to rollover a 401(k) into an IRA: 2 methods

If you’re looking for greater control over your investments or want to consolidate your IRA accounts, a rollover may be right for you. There are two ways to transfer your funds, and learning the difference can prevent you from making costly 401(k) rollover mistakes.

1. Direct rollover of your 401(k) into an IRA

With a direct rollover, your 401(k) provider funds the IRA directly. How you’ll be taxed depends on the account type: 

• Traditional 401(k) to traditional IRA: Taxes are deferred, so nothing is due during the transfer.
• Roth 401(k) to Roth IRA: No taxes are due since both accounts are funded with after-tax dollars.
• Traditional 401(k) to Roth IRA: Traditional 401(k)s are funded with pre-tax dollars, and Roth IRAs are funded with after-tax contributions. So, you’ll owe income taxes during the rollover.
  

2. Indirect rollover of your 401(k) into an IRA

With an indirect rollover, your 401(k) provider closes your account and deposits the funds into your bank account. If you deposit the full amount into an IRA within 60 days, the IRS won’t penalize or tax your money. But if you don’t deposit 100% of the funds, you’ll have to pay taxes plus a 10% early withdrawal penalty on the remaining portion.

Additionally, the 401(k) plan administrator will hold 20% for taxes. You’ll need to replace this 20% using personal funds to complete a full rollover and avoid taxes and fees.

Should you roll your 401(k) into an IRA?

The answer depends on your financial goals, career stage, and desire for flexibility. A rollover might be an option if: 

• You have 401(k) funds still invested with a former employer.
• You want more investment options and lower fees.
• You want to consolidate your savings into one retirement account.

Although rollovers appeal to some, it may be an option if:f:

• You want to contribute more than $7,000–8,000 per year.
• You want access to institutional pricing rates and stable value funds.
• You’re planning to retire between ages 55 and 59½. 

FAQ

What’s a rollover IRA?

A rollover IRA lets you deposit funds from a company-sponsored account into a personal retirement plan. This differs from a traditional IRA, which you can open with any funds.

Is a 401(k) an IRA?

No, these are two different retirement vehicles. A 401(k) is an employer-sponsored retirement plan, while an IRA is an individual retirement account.

If I leave my job, do I have to roll my 401(k) into an IRA?

You’re not required to roll 401(k) funds from an old employer into an IRA. . You can also leave your money in the existing plan, roll it over into your new employer’s 401(k), or cash it out. But if you’re under 59½, the payout may be subject to an IRS early withdrawal tax penalty.

Plan your retirement with Gainbridge

Once your funds are securely in an IRA, you’ll need to invest them into other assets to earn interest. Annuities are a popular choice since they often offer solid yields and guaranteed retirement income. Gainbridge offers fixed rates without any hidden fees, so your funds go further in retirement. However, there is no additional tax benefit to include an annuity in an IRA.

Learn more about Gainbridge today.

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This article is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. The Gainbridge® digital platform provides informational and educational resources intended only for self-directed purposes.

Annuities issued by Gainbridge LIfe Insurance Company located in Zionsville, Indiana.