Pros and Cons of 401(k) Rollover: Examining the Four Options

Leaving a job is both exciting and stressful. On one hand, the change could bring new opportunities for growth and development. However, leaving a job also means that you have to make an important decision regarding what to do with your retirement account. There are four options available, each with its own advantages and drawbacks. In this blog post, we will examine the pros and cons of 401(k) rollover options.

The four options available to you are:

• Rollover into IRA
• Keep with your former employer plan
• Move to a new employer plan
• Cash out

No matter which option you select, there are certain considerations that you will need to keep in mind. With any type of 401(k) rollover, there will be two choices for transferring the funds: indirect rollover and direct rollover. With a direct rollover, the account balance is automatically rolled over without any taxes being withheld. If you elect to perform an indirect rollover, you will receive a full distribution of funds that needs to be deposited into an eligible retirement account within 60 days. If you don’t deposit the full amount, or if you wait longer than 60 days, you will face tax implications.

Option 1: Rollover into IRA

Rolling over from a 401(k) into an IRA is an excellent option for anyone looking to increase the diversity of their retirement accounts. The fees involved with managing your IRA account are sometimes lower than 401(k)s, but the fee structure will vary according to your plan. The freedom associated with managing your own IRA will allow you to search for lower-cost funds and expand the options available to you. This ability to choose is perhaps the most welcome benefit of rolling over your 401k into an IRA, and you will be able to select a trusted advisor to manage the fund, such as Morgan Rosel Wealth Management.

Although an IRA offers freedom and variety, it comes with a few caveats. Firstly, you will not be able to access the funds (without incurring tax penalties) until six months after your 59^th birthday. With 401(k) plans, this is not the case, as you can avoid the 10% early-withdrawal penalty if you leave your job after age 55 and want to access funds before age 59 1/2. A second drawback to holding your money in an IRA is that they are not as well protected from lawsuit claims as a 401(k) account.

If you decide to rollover into an IRA, you must then decide if you will use a Traditional IRA, a Roth IRA, or a combination of the two. The most prominent difference between Traditional and Roth IRAs is when the contributions are taxed. To learn more about each IRA option available, please refer to our Tax and Financial Advisor’s Guide to IRAs or contact a Morgan Rosel investment advisor.

Pros and Cons of 401(k) Rollover into IRA

+ IRA gives more investment options including funds with lower expense ratios

+ IRAs may have some tax advantages

+ IRAs can be managed by a trusted investment advisor

– Won’t be able to access until 59 ½

– Not as well protected from creditor claims as 401(k)

Option 2: Keep with Former Employer

The path of least resistance involves keeping your 401(k) with your former employer. There is no time limit for when you need to move the money; however, certain plans may require you to maintain a minimum balance to manage the plan. If your account balance is less than $5,000, you will need to check with your plan manager to confirm that you don’t fall below the minimum threshold. This flexible time limit for rolling over may entice you to stay with your former plan, at least until you can identify a new option. Keeping your old 401(k) may also be a wise choice if your new employer doesn’t offer a 401(k) program, or if the new plan has limited investment options and/or high fees.

Despite being an easy option because no action is required, maintaining your old 401(k) may present difficulties. Most notably, the old 401(k) account will require additional monitoring for performance and major changes. Another glaring drawback is that you will most likely lose the ability to make additional contributions and will no longer receive employer matching. One final item to consider is whether or not your plan contains shares of your former company’s stock. If so, there may be possible tax implications due to net unrealized appreciation. Consulting with a tax advisor and wealth manager can help avoid unnecessary penalties and provide you with the most tax-advantaged strategy.

Pros and Cons of Keeping 401(k) with Former Employer

+ No action required

+ Can still rollover in the future

+ Familiar investment options and fees

– Extra monitoring for additional account

– May lose ability to contribute

– Possible tax implications if company stock is in plan

Option 3: Move to New Employer Plan

Assuming you decide to participate in the new employer 401(k) the benefit of being able to actively contribute to the plan and manage your entire 401(k) in one place can be quite convenient. The contribution limit for 2023 is up to $22,500 annually, which includes any potential employer match amounts. Only having one account will also decrease the number of plans that you need to monitor, which will save you time and help decrease the stress of account management.

Drawbacks associated with moving to a new plan are mainly concerned with the lack of control that you have over the plan. Compared to an IRA, or even having multiple 401(k) plans, keeping most of your retirement funds in one 401(k) account limits your investment options to whatever is available in the 401(k) plan your employer chooses. When switching to a new plan, you may also experience higher fees or different management rules.

Pros and Cons of 401(k) Rollover to New Employer Plan

+ Easily manage and monitor investments in single account

+ Actively contribute and receive possible employer matching 

– May have fewer or less desirable investment options in new account

– Possibility of higher fees and different rules

Option 4: Cash Out

Except in extremely dire circumstances, this option should be avoided at all costs. The only positive is that you receive an immediate cash distribution, but unless you are over 59 ½ (and in some cases 55) the influx of cash comes with heavy strings attached. In addition to ordinary income tax, your cash disbursement will also be subject to a 10% early withdrawal fee. In addition to costly taxes and fees, withdrawing from your 401(k) retirement account halts financial growth of the account. Unless you have no other choice, it is best to keep your money invested in a 401(k) plan or roll it over into an IRA.

Pros and Cons of Keeping 401(k) with Former Employer

+ Cash now

– Pay ordinary income tax + 10% early withdrawal penalty 59 ½

– Growth stagnation

What Should You Do with an 401(k) After Switching Jobs?

Deciding what to do with your 401(k) after leaving a job can be a complex decision. We feel that for considerable flexibility and choice, moving your 401(k) to an IRA managed by trusted fiduciary investment advisors is the preferred option. However, there is not necessarily a right answer as the decision depends on your personal financial situation and your retirement goals. Having a trusted financial advisor like Morgan Rosel Wealth Management can help take the stress and uncertainty out of investment management. We will weigh the pros and cons of 401(k) rollover options and help guide you into retirement and beyond. If you are planning on switching jobs, or have recently done so and have not yet addressed your old 401(k) plan, we’d love to chat.

The Value of Working with a Local Wealth Advisor Near You

When you’re starting a relationship with a new wealth advisor, meeting face to face is an incredibly valuable experience. At Morgan Rosel Wealth Management, we meet with clients in Highlands Ranch and the surrounding Denver Metro areas. In order to best understand your goals, the situation with your 401(k) rollover, and develop a wealth management and retirement strategy that keeps your best interests in mind, we recommend coming into our Highlands Ranch office and sitting down with a trusted financial advisor and CERTIFIED FINANCIAL PLANNER™. Learn more about the process of working with Morgan Rosel Wealth Management here.