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Doing an IRA Rollover Can Save on Fees and Give You Better Options

Quick Summary

  • A rollover is when you move the money you saved in your 401(k) at work to an IRA you control. Most rollovers happen when people retire or get new jobs.
  • Direct rollovers are relatively simple and do not trigger any new taxes.
  • Doing a 401(k) rollover can frequently help you save on fees and take advantage of better investment options.

Introduction: 401(k) Rollover Options

If you are leaving a job and you’ve saved in a 401(k) or similar plan, you’ll want to figure out what to do with the money you’ve accumulated while at that job. Frequently, but depending on the 401k rules, you can leave your savings where they are. If you choose to move the money from a 401(k) to an IRA, this is called a “rollover” and can often be a good idea.

You can decide which option to choose based on four factors:

  1. Will I owe taxes on my rollover?
  2. Can I save on annual fees?
  3. What about my investment options?
  4. How easy is it to manage your money?

Then there’s one other point: The One Thing You Don’t Want to Do

Tax Implications

The government gives people tax breaks on retirement savings. But different kinds of retirement accounts have different tax breaks. When you are doing a rollover, you can decide to pay your taxes now or keep deferring them until retirement.

401(k) to Traditional IRA Rollover

A direct rollover is the most common type of rollover and is done by your 401(k) plan administrator. You won’t owe taxes if you do a direct rollover from a regular 401(k) to a Traditional IRA. You will pay taxes when you retire and start to draw money out. (Note that the rules are different for a Roth 401(k), as will be noted below.)

Some people chose to do an indirect rollover from a 401(k) to a Traditional IRA. An indirect rollover is when you withdraw the money from your 401(k) and hold it for 60 days or less before depositing it into the same or another 401(k) or IRA. Usually people do an indirect rollover if they need a loan of their retirement money. Indirect rollovers can trigger taxes or tax-reporting depending on how you do them.

401(k) to 401(k)

If you roll your 401(k) balance over to another 401(k) at a new job, you won’t pay taxes. You will pay them when you retire and start withdrawing the money.

401(k) to Roth IRA

You can do a rollover between a regular 401(k) and a Roth IRA, but it requires that you make a stop at a Traditional IRA first. You do a 401(k) rollover first. Then you do a Roth IRA conversion.

You will pay taxes on the money when you convert to the Roth. (The reason: You got a tax deduction for your contributions to your regular 401(k) and paid no taxes to move it to a Traditional IRA, which is also designed to hold pre-tax money.) A Roth, on the other hand, is a retirement savings plan for after-tax money. The benefit:  When you withdraw the money from the Roth IRA after you are retired, you won’t owe taxes.

If you think your tax rate is higher now than it will be in retirement, it could be smart to roll over to a Traditional IRA. If you think your tax rate is lower now than it will be in retirement, it could be smart to roll over to a Roth IRA. Whether taxes are higher or lower depends on how much you earn and whether the government is raising or lowering taxes.

Note that if your 401(k) is a Roth 401(k), you can roll it over directly into a Roth IRA without intermediate steps or tax implications. Both accounts contain after-tax money . You just have to check how to handle any employer matching contributions because those will be in a companion regular 401(k) account.

Fees

Fees can make a big difference on how much money you have when you retire. If you stick to low-cost investments in your IRA, you will probably pay less in an IRA than in a typical 401(k).

There are two important kinds of fees when it comes to rollovers. One kind is the fee that you are charged for your account. The other is the fee on the underlying investments—the mutual funds or ETFs—in your account.

Your 401(k) administrators should be able to give you a total cost for your retirement plan, in terms of the percent of your assets that you are paying. It will include the fee on the account and for the funds. Costs for typical 401(k)s can range from very low—under .5 percent a year—to quite high, as much as 2 percent.

Most banks and brokerages charge nothing or a nominal fee for an IRA or Roth IRA. If you stick to low-cost mutual funds and ETFs, those with fees of less than .5 percent, you will end up paying less than in a 401(k.) Broad-based index bond and stock funds often are good choices.

Investment Quality and Selection

IRAs often have a wider array of mutual funds, ETFs and other investment products, such as annuities, to pick from. Some 401(k)s have a good selection, too. Make sure whichever option you pick has a selection of low-cost funds to pick from.

You might also wish to hire an investment advisor to help you decide which investments to hold in your retirement fund, whether it is an IRA or 401(k). Be sure to include the cost of the advisor when you add up the fees you are paying.

How Easy Is It to Manage Your Money

Finally, you might find it easier to manage your money if it is all in one account. That could mean doing a rollover each time you leave a job. You could roll over into your next job’s 401(k), if there is one. Or you could do a rollover into one IRA or one Roth IRA each time you switch.

Check your 401(k)’s rules on how easy it is to withdraw money or take out a loan. Some 401(k)s are more flexible than Traditional IRAs when it comes to withdrawal rules. If you withdraw money from a Traditional IRA before you are 59½, the withdrawal is taxable. Often, withdrawals are also taxed an extra 10 percent, with a handful of exceptions, including for some medical expenses and education. You can see a list of exceptions here.

Compare the IRA rules to your 401(k) rules to help you make a decision.

Roth IRAs offer the most flexibility of all. You can typically withdraw the total of your contributions (though not the income it earned) with no penalty.

The One Thing You Don’t Want to Do

There is one other rollover option: Cashing out your 401(k). But if you do that, you’ll be robbing your future self of the money you need to live on in retirement. And, if you’re under 59½,  you’ll likely get a whopping tax and penalty hit, as well.

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