Should I Roll my 401(k) into an IRA?

A 401(k) account is a professional advisory managed account and is the starting point for retirement planning. A 401(k) account is activated when you gain full-time employment and opt for it, and a portion of your paycheck is then directly invested in it. Your employer may contribute a part (up to 10% of the total monthly salary of the employee) or often match the employee contribution. The money accumulated is then invested in funds such as mutual funds and will earn interest to sustain you financially when you have retired and no longer have a regular salary to maintain your lifestyle.

According to a recent report from the American Benefits Council, more than 80 million people in the US actively contribute towards a 401(k) plan. As of June 30, 2020, the 401(k) fund had an estimated $6.3 trillion worth of assets. This represents one-fifth of the entire $31.9 trillion US retirement market, which includes employer-sponsored programs, annuities, defined contribution plans, and even individual retirement accounts (IRAs). That said, 401(k) accounts owe their popularity primarily to the tax-advantages they offer. A 401(k) account does not tax the 401(k) investment earnings until you begin to withdraw them, which is typically done after retirement. Hence, since its inception in 1978, 401(k) plans have grown to be one of the most coveted retirement plans in the US. 

If a provision for 401(k) exists in your workplace, it is wise to make full use of the opportunity and contribute as much as possible towards this retirement account. Click here to read about why a 401(k) is a great idea and how it works to grow a healthy corpus for retirement.

While a 401(k) account provides several advantages for retirees, they also have drawbacks, such as strict restrictions, penalties, and tax implications on withdrawals. In order to overcome a few disadvantages that come with the 401(k) account, you may consider rolling your 401(k) plan into an IRA. An IRA or Individual Retirement Account is a tax-advantaged retirement savings plan with special benefits over the 401(k) plan. Should you choose to convert your 401(k) plan into an IRA, you can take advantage of long-term, tax-deferred growth of your funds and a broader range of investments compared to a 401(k) account. An IRA also offers several exemptions during the withdrawal of your funds. However, keep in mind that the suitability of the rollover from a 401(k) account into an IRA ultimately depends on your financial situation and retirement objectives. 

An IRA has traditionally yielded better post-tax returns for an investor than a 401(k) has. Click here to read about how an IRA works and the contribution limits and eligibility criteria for the account.

To make an informed decision about rolling your 401(k) into an IRA, it is best to take a look at the benefits and drawbacks of the conversion.

What are the Advantages of Rolling my 401(k) into an IRA?

Here are some of the top reasons that justify rolling your 401(k) into an IRA:

1. Wider investment choices 

In a 401(k) account, your investment choices are limited to mutual funds – equity funds, debt funds, and bond funds. However, with an IRA, your scope of investment expands to include not just mutual funds but also individual stocks, bonds, ETFs, real estate, etc. Moreover, with an IRA, you can buy or sell your holding anytime, unlike the 401(k) plan. Most 401(k) plans limit the number of times you can buy or sell your holdings or rebalance your portfolio.

2. Lower fees and costs 

Usually, IRAs have significantly lower management fees, administrative charges, and fund-expense ratios, compared to a 401(k).The transaction costs are also high in a 401(k) account as compared to an IRA.

3. Lesser rules

An IRA has comparatively standardized rules that are determined by the IRS. However,in a 401(k) account, the terms differ for each employer plan and can get quite complicated.

4. Lower taxes

In a 401(k) account, the IRS mandates that 20% of distributions be withheld for federal taxes. However, in an IRA distribution, there is no specific percentage, and one may even choose to have no tax withholdings. Having said that, it is good to allow a small percentage to be withheld to avoid a hefty tax bill at the end of the year. With an IRA, you get to choose a withheld amount that accurately reflects the actual amount you owe instead of an automatic 20%.With an IRA, you are not required to use your retirement savings faster than needed, and hence, your money may benefit from compounding on a tax-deferred basis.

5. The Roth advantage

A critical advantage of a rollover is the facility made available by a Roth IRA.In a Roth IRA, you pay taxes at the time of contribution. Hence, there is no tax due when you withdraw them. This means you pay taxes when you continue to earn and can afford taxes eating into your earnings, instead of deferring them to be paid post retirement when there is no stable income. With a Roth IRA, you do not have to take RMDs (Required Minimum Distributions) at age 72 either.

What are the Disadvantages of rolling a 401(k) into an IRA?

Here are some disadvantages of an IRA rollover:

1. Non-availability of loans

Unlike a 401(k), you will not be able to borrow any money from an IRA.For an employer-sponsored plan like a 401(k), you may take a loan from your account to meet an urgent expense.

2. Rigidity on withdrawals

With a 401(k) account, you can avoid paying the 10% early withdrawal penalty if you leave your job at the age of 55 or after the age of 55. However, with an IRA, you can only take money out if you are 59.5 years old, unless you pay an early withdrawal penalty at a rate of 10%. You can also get favorable tax treatment on withdrawals if your 401(k) is directed in company stock, an option that isn’t available with an IRA.

3. Restricted buying power

In a 401(k), you can buy funds at institutional pricing rates, owing to group buying power, which is not the case with an IRA.

4. Lack of legal protection

Unlike an IRA, a 401(k) account may provide better protection from lawsuits, bankruptcy, and creditors since it is protected by federal laws. Alternatively, IRAs are only shielded by state laws, whose jurisdiction varies.

When Should I Consider Rolling Over my 401(k) into an IRA?

You should opt for a 401(k) into an IRA rollover, if:

  • You believe you will be in a higher tax bracket, or if tax rates are likely to be higher during your retirement.
  • Your existing 401(k) plan has high-cost investments and underperforming funds. 
  • You have multiple 401(k) accounts, and management has become an issue because of frequent changes in jobs.
  • You need more bond funds because your 401(k) has a line-up of weak stocks with a low fixed-income.
  • You need more flexibility in terms of withdrawals.

On the other hand, you should not opt for a 401(k) into an IRA rollover, if:

  • You plan to retire early and hence, need early withdrawals.
  • You want to contribute to a Roth IRA, but your earnings exceed the income cap.
  • You want to avoid the potential for any kind of legal battle or lawsuit altogether.

Which IRA Should I Rollover to?

If you are sure about converting your existing 401(k) plan into an IRA, be sure you choose the right type of IRA for conversion. Here are some guidelines:

  1. If you expect your taxable income or overall tax brackets to be lower during the latter part of your life, choose a traditional IRA. However, choose a Roth IRA if you expect your taxable income or the overall tax brackets to be higher during your retired years.
  2. If you are a high net worth individual (HNI) or a high income-earner, a traditional IRA may suit you better than a Roth IRA because the former has no cap on income. There are certain income limits in a Roth IRA that prevent highly earning investors from contributing to a Roth IRA.
  3. If you wish for penalty-free early withdrawal, do not opt for a traditional IRA; instead, rollover to a Roth IRA, as it allows for withdrawals (subject to some conditions) at any time and without a penalty.
  4. A Roth IRA requires that you lock in your money for a minimum period of 5 years before you tap into the earnings, and a pre-withdrawal is subject to penalties. With a traditional IRA, there is no minimum time restriction before you take a distribution of money. However, you must wait until you are 59 ½ years old before removing money from any of your retirement accounts in general.

How do I Rollover my 401(k) into an IRA?

Rolling your 401(k) into an IRA is fairly simple.

  • Contact your 401(k) plan administrator (or the HR department at the company you are currently employed at) and explain what you want done, and get the application forms for the same.
  • Then, get in touch with the concerned custodian of your chosen IRA (a traditional IRA or a Roth IRA) and open an account.
  • Once the account is active, use the forms provided by your company’s 401(k) plan administrator to request for a direct rollover of funds into your chosen IRA. Upon approval, the administrator will transfer the funds into the requested account. Alternatively, you can choose to have the administrator give you a cheque in the name of the IRA. Be sure that the cheque is not presented as a distribution. You could also opt for an indirect rollover, where 20% of your 401(k) will be withheld for taxes by the administrator. You may apply for a tax refund later.

How long do you have to Complete the Rollover?

There is generally no time limit for a direct rollover of your 401(k) plans. Once the IRA is set up, your money will simply be transferred to the new account. This happens quite seamlessly. However, should you opt for an indirect method of a rollover, that is, if you want to take possession of the funds from one retirement account and personally reinvest the money into another retirement account, a 60-day limit applies. The IRS allows you 60 days, from the date you receive your retirement plan distributions, to roll it over into another plan or an IRA of your choice. The IRS may waive the 60-day rollover requirement in certain situations if you missed the deadline because of circumstances beyond your control. You can only do one rollover in a period of 12 months.

Taxation and Penalties In a 401(k) Rollover

  • When you roll over a 401(k) to a Roth IRA, you will pay income tax on that money in the year you make the switch. But there will effectively be no tax on the entire balance when you retire.
  • When you make the conversion from a 401(k) into a Roth IRA, your funds inherit the same timing as the Roth IRA money. This means that the holding period for the IRA becomes the same for all the money in the account. Hence, to ensure penalty-free withdrawals, you must hold the funds in a Roth IRA for a minimum of five years. Withdrawal of money before the 5-year rule lapses can result in a 10% penalty and income taxes.
  • As mentioned, if you opt for an indirect rollover, you need to complete the conversion within 60 days from the receipt of the 401(k) distributions. If you miss the deadline, you pay withholding taxes (20%) and penalties.

That said, it is possible to evade the taxes and penalties if the rules for the rollover are adhered to. Additionally, even if you rollover into an IRA, it is advised to be wary of required minimum distributions (RMDs). The IRS mandates you to start taking RMDs from your IRA, 401(k), etc., by the age of 72 years to avoid any tax charges and penalties. However, the RMDs for 2020 were suspended by the government to extend support to the investors, allowing their portfolios to recover from the market slumps induced by COVID-19.

Should I roll over my 401(k) into an IRA?

This is essentially a tricky question to answer. The ultimate decision of rolling a 401(k) into an IRA depends on your financial situation and goals. If you want lower taxes and fees, fewer rules, more investment choices, better communication, and the possibility to shift to a Roth IRA, you should go ahead with the rollover from a 401(k). According to The Pew Charitable Trusts, more than 33% of the private-sector employees do not have access to a 401(k) plan at their workplace. This leaves many with no other option than to invest in an IRA for their retirement.

As per trend studies, an average American retiree is expected to have around 85% of their pre-retirement income to be able to maintain a conservative lifestyle in retirement. Retirement savings plans like a 401(k) account could fall short of this estimate, due to various factors that influence your savings. For one, the 401(k) account has restricted potential to earn higher interests because of the lesser choice of investment avenues it offers. Secondly, inflation could make goods and services more expensive in the future than it is now. Experts believe the 401(k) is not prudent enough in its investing strategy to beat the rate of inflation. Having only a 401(k) to fall back on could possibly leave you with lesser funds than anticipated during your retirement years.

What are other Alternatives to Rolling my 401(k) into an IRA?

Apart from the rollover, some other options for your 401(k) plans include:

  • A 401(k) to a new 401(k) transfer: If you are joining a new company, you can rollover your traditional 401(k) balance to a new 401(k) without paying any taxes. 
  • A 401(k) to a Roth 401(k) transfer: Some companies also allow you to roll over your traditional 401(k) account into a more tax-beneficial Roth 401(k) plan.A Roth 401(k) is similar to a 401(k) account, which includes after-tax contributions up to a specified limit and provides tax-free distributions during your retirement. A Roth 401(k) hosts the best features of a traditional 401(k) account and a Roth IRA. 
  • Net Unrealized Appreciation (NUA): You can also use the NUA privilege. Some companies allow employees to own their stocks to give employees a sense of ownership. NUA is the variance between the cost of employer shares and the current market value of the stock. So, if you own high-appreciated company stock in your 401(k) holdings, you can use the NUA advantage. The IRS charges favorable capital gain tax rates on the NUA of the employer at the time of distribution, subject to some specific qualifications.

Bonus: Tips for Retirement Investing

Here a few useful tips to keep in mind when investing your hard-earned money:

Know your taxes 

When planning for retirement, consider the laws of the state you live in. Some states have tax laws that are flexible and friendly for retirees, but some states do not. So, check your state taxes, or consider relocating to a state that has better retirement laws if needed.

Plan in advance 

Always be a wise planner, and determine how much you will need during the golden years of your life. Once you know your retirement income needs, make a comprehensive plan, and structure your investment portfolio to achieve the goal.

Get professional help

Consider seeking expert consultation from a financial planner in regards to making the right investment choices and saving for a better retirement. Your financial advisor can also help you effectively lower taxes, as well as choose the best retirement savings plans and efficiently conduct a rollover when needed.

If you are not sure where to start looking for an advisor, use Paladin Registry to help you find a top-quality financial advisor to manage your finances. Answer a few simple questions and get matched to 1-3 financial advisors without any cost.

To sum it up

The final choice of a rollover of a 401(k) into an IRA depends on the suitability of each account, as per your and financial situation and objectives. Each plan has its pros and cons, and hence, you must research well and make an informed decision. If you feel a rollover is complicated and confusing, you can find a professional financial advisor through Paladin Registry’s free match tool to get the right guidance.

If you need any further clarifications or have any questions, visit Dash Investments or email me at

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. In addition, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.

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