The 401k and an Individual Retirement Account (IRA) are similar retirement accounts. Both offer tax advantages, such as tax-deferred and tax-exempt growth. The two accounts also have two types, each based on taxation rules. The traditional 401k and IRA offer tax-deferred growth on contributions but tax you in retirement for withdrawals after the age of 59.5. On the other hand, the Roth 401k and IRA tax you in the present, but your withdrawals after the age of 59.5 are exempt from tax. The similarities and benefits are the reason why most people roll over their 401k accounts to an IRA.

There can be several reasons for rolling over your 401k to an IRA. You may do so if you are shifting jobs and your new employer does not offer a 401k. You can also roll over to an IRA if you quit your job and decide to start a business. However, you must follow the correct procedure to ensure that you gain from this activity. While the general perception is that there are no fees for rolling over 401k and that the rollover is entirely free, there are some hidden costs associated with a rollover. It is essential to know what these are to lower the overall costs and make an informed decision that benefits you and does not financially harm your growth. Consult with a professional financial advisor who can help you smoothly roll over your traditional 401k and IRA into a Roth account after taking into consideration any related hidden costs. Keep reading to learn more.

Does rolling over a 401k cost money?

Ideally, there are no 401k rollover fees when you transfer funds from a 401k to an IRA. You can look for a broker and initiate the rollover free of cost without any direct charges. In some cases, the broker may also extend a discount or reward for opening an account. Brokers are very welcoming when you set up an account, especially a long-term plan like the IRA that can offer them a commission for years.

However, there can be some hidden costs of a rollover. The fees of both accounts differ. These differences might seem small at first, but they can cost you a lot of money in the long run. The Pew Charitable Trusts researched the lifetime costs and earnings from a 401k and an IRA. The study showed that the fees for an IRA are considerably more than a 401k. The Trust used the example of an average 65-year-old with a hybrid 401k mutual fund with $250,000 in savings. The individual planned to withdraw $1,000 per month for Social Security benefits for 25 years. If this individual selected a 401k, the annual fee amounted to 0.46%. However, if the individual chose an IRA, the total incurred cost amounted to 0.65% for the same investment.

Should you consider a 401k rollover?

When you quit or change jobs, you have four options. You can pick any of these options as per your needs and preferences. However, it is essential to consider the pros and cons of each:

1. As discussed above, you can roll over your funds to an IRA:

If you wish to switch your funds to an IRA, you would have to first understand the fees associated with an IRA. An IRA can charge a number of fees, such as the account opening fee, maintenance and advisory fees, transaction fees and commissions, etc. Some companies also have a minimum account balance. This can be as low as $25 and can go as high as $500.

Most companies do not charge for opening an account. However, the maintenance and advisory fees can range from as low as $3 to $5 per month to $40 annually. It can also be charged as a percentage of your assets. This can range between 0.25% and 0.90 % annually. Transaction fees and commissions can be charged as a percentage of the principal amount or a fixed minimum commission. On average, the monthly cost of maintaining an IRA can range between $30 and $50.

In addition to the costs, you must also understand that you would be opening an IRA on your own. So, you would have more room for choice in terms of picking the plan administrator and investments. However, you would lose out on the employer’s match, if any.

2. You can keep your old 401k:

If you have more than $5,000 in your old 401k, your company may allow you to continue with your old plan even after quitting your job. This is particularly helpful if you like your old plan and are happy with your investments so far. However, make sure to continually review it and keep note of your investments and their performance. If you choose this option, there would be no additional fees for rolling over 401k, hidden or otherwise.

If you have less than $5,000 in the old plan, the employer will cut you a check, and you will have no other option but to roll over to a new 401k or an IRA. If not, you will incur taxes and a penalty if you are under the age of 59.5. And while you will not incur any 401k rollover fees, you will suffer other setbacks. These include not being able to add any more money to the account or apply for a loan.

3. You can move your 401k funds to the new employer’s plan:

If the new employer offers a 401k, you can move your funds once you have joined the new company. However, before doing so, make sure to go through the new plan options and fees. If your new employer offers an employer match, you would also benefit more in the long term with dual contributions.

There are two ways to do a rollover. You can either opt for a direct rollover. This is done from one custodian to another, and you do not pay any additional fee or tax. The other option is to opt for the indirect rollover. If you select this option, your old employer will cut you a check. You must deposit this check within 60 days into the new account. If not, the total amount will be seen as an early withdrawal, and you will be taxed on it. Additionally, if you are under the age of 59.5 years, you will also pay a 10% penalty on the total balance. Further, your old employer will also keep 20% of the balance for federal income tax purposes.

4. You can cash out your 401k:

If you are over the age of 59.5 years, you can consider cashing out your 401k. This will be seen as a normal distribution and taxed depending on whether you have a traditional or a Roth 401k. This can be ideal if you are retiring or quitting your job to start a business. With no possibility of an employer match or a new 401k, cashing out can be a viable option.

However, keep in mind that any distributions made before age 59.5 will be subjected to a 10% penalty and tax, irrespective of whether you have a Roth or a traditional account.

When does it make sense to consider a 401k to IRA rollover?

An IRA rollover can have several advantages if used correctly.
Here are some ways in which a 401k to IRA rollover can be helpful:

1. You have larger variety of investments:

401ks typically include company stocks, target date funds, bonds, etc. These can be restricted in terms of financial growth. An IRA, on the other hand, offers a broader selection. You can invest in individual stocks, mutual funds, cash, Certificates Of Deposit (CDs), bonds, and more. This helps you diversify your investments better and offers more room for choice based on your varying needs and goals. In addition to this, some companies restrict the number of times you can rebalance your portfolio in a year. However, there is no such limit on an IRA. So, you can frequently switch from one investment to another and make the most of the changing market dynamics.

2. You have the option to convert to a Roth account:

Roth accounts are not taxed in retirement if the distributions are made after the age of 59.5 years. This helps you keep the value of your retirement fund intact and enjoy retirement without tax liabilities. If your old 401k is a traditional account and your new employer also offers a similar one, you can switch to a Roth IRA to enjoy better tax benefits in retirement. Having said this, it is crucial to ascertain what your tax liabilities are likely to be in retirement. A Roth account can be beneficial if you think you will be in a higher tax bracket in retirement. However, if you are in a higher tax bracket right now, it makes sense to stick to a traditional account.

3. You may have increased flexibility:

Employers have a lot of control over 401ks. They may have a say in the choice of investments, the number of times you can rebalance your portfolio, the rules for taking loans, etc. Contrarily, IRAs are very flexible. You get to choose your plan administrator, investments, etc. You can review your portfolio multiple times.

4. You benefit from broker incentives:

When you open an IRA with a broker, you bring them business for a long period. This is an excellent incentive for them. This is why brokers often reward new IRA holders with stock trades, cash, and more.

5. Inheritors benefit from flexible payouts:

In most cases, companies are in a rush to transfer the funds in a 401k to the concerned nominee in the unfortunate event of the account holder’s death. Because of this, companies may not offer multiple payout options to beneficiaries. This, in turn, triggers higher tax liabilities for inheritors. An IRA is also taxed upon inheritance. However, the plan offers more payout options for inheritors to choose from, allowing them to effectively use the funds for their needs and manage taxes.

6. You may have better control of your investments:

If you leave your funds with the old employer, you may find it hard to track your investments regularly. The old employer may also not take as much interest in your account. In the case of any issues, you may not get the same time and attention from the old employer. However, with an IRA, you will always be in control of your investments.

Are there any cons to a 401k to IRA rollover?

Despite the many advantages, there are some cons to an IRA rollover, such as:

1. Hidden fees for rolling over 401k:

The overall cost of maintenance is higher in an IRA than in a 401k. There are many hidden 401k rollover fees in the form of IRA maintenance, account opening, etc., as discussed above, that can increase your expenses and interfere with your returns.

2. Lower contribution limits:

As of 2022, you can contribute up to $6,000 to an IRA if you are under the age of 50 and $7,000 if you are 50 or older. On the other hand, you can contribute up to $20,500 to a 401k if you are under the age of 50 and $27,000 if you are 50 or older. The difference is significant and alters your final return significantly.

3. No employer contributions:

There is always the possibility of earning an employer match in a 401k, however big or small. The total contribution limit for employer and employee contributions is $61000 for those under the age of 50 and $67,500 for those aged 50 or older as of 2022. Contrarily, there is no employer contribution to an IRA. So, you lose out the money in the long run.

To conclude

No matter your selection, it is vital to understand your investments’ present costs and future growth potential. An IRA may charge higher fees and low contributions, but it can offer better control and increased flexibility. On the other hand, a 401k can provide higher contributions and lower costs but lacks control and flexibility sometimes. Therefore, make sure to pay attention to these factors along with the lesser-known and often hidden fees for rolling over 401k and then make a decision.

Moreover, you must also make sure to consult a professional financial advisor when in doubt. This can eliminate the scope for errors and ill-informed decisions. Use WiserAdvisor’s free advisor match service to find highly qualified and vetted financial advisors who can guide you on the same. Answer a few questions about yourself and get matched with 1-3 financial advisors that are suited to meet your financial requirements.

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