Updated: May 19
If you’ve recently changed jobs (or have changed jobs at some point in the past), you have several options of what you can do with your 401k plan. You can:
cash it out (not advisable due to taxes and penalties)
Leave it with your current plan administrator
transfer it into your new employer's 401(k) plan
roll it over into an IRA
For most people, rolling your 401k into an IRA is by far the best option. Below are 7 reasons why:
1. Better Investment Choices
Employer-sponsored 401k plans commonly offer limited investment choices, in all likelihood to a small selection of mutual funds for bonds and equities that the plan administrator has selected and is earning fees on.
However, with an IRA, almost all types of investments are available to you, including individual equities, bonds, ETFs, real estate, options, commodities, gold/precious metals and Bitcoin. It’s even possible to hold income-producing real estate in your IRA.
An additional benefit is that can buy and sell whatever you want, whenever you want instead of the limited number of times per year you are usually allowed to buy and sell or "rebalance" your portfolio in a 401k plan.
2. Better Communication
When you leave your 401k with your old employer plan, you lose access and communication regarding the plan and it becomes a lot more difficult to get in touch with an advisor or administrator of the plan. HR is no longer working there to work on your behalf if you need things done. A huge risk is of leaving your plan with an old employer is the unlikely event they go bankrupt. Your 401k will likely get frozen by the court and you’ll have no access until the bankruptcy is resolved.
3. Lower Fees and Costs
As Andrew Yang would say, it's about the math. Everyones situation is going to be different so you’ll have to do the math, but rolling over into an IRA often can save you a lot in management fees, expense fees and fund expense ratios. There's a whole bunch of little costs that add up and can eat into returns over time. Usually, the mutual funds offered by 401k plans are more expensive than the norm. You should always be careful about the transaction costs with certain investments and expense ratios, 12b-1 fees (marketing and distribution fees built into expense ratios) or loads associated with mutual funds. However, to be fair, the bigger 401k plans have access to institutional funds that can often charge lower fees than retail counterparts. IRAs, of course, won’t be free of fees either, but you’ll have more control and choices of how and what you’ll invest in and what you will ultimately pay.
4. The Roth Option
The Roth IRA is in our opinion the greatest tax-advantaged vehicle to invest for retirement if you can manage it. Once you rollover your 401k to an IRA, it opens up the possibility of a Roth Account or q backdoor Roth IRA conversion even if your income is too high to open a Roth IRA the regular way. With a Roth IRA, you pay taxes on the funds you contribute when you contribute them and you never pay taxes again when you withdraw. If you believe the value of your IRA will increase significantly between now and the time you retire or you’ll be in a higher tax bracket when you retire, the Roth is the way to go.
Two additional benefits of a Roth are you don’t have to take RMDs(required minimum distributions) at 72 or ever and if you're under the age of 59½, and you need money, it's a lot easier to withdraw funds from a Roth IRA than from a traditional IRA. There are no early-withdrawal penalties for contributions, in most cases, though there are for any earnings.
5. Less Rules
401ks can be complicated since every company has a lot of flexibility in how they structure their plan. IRAs however, are standardized by the IRS. Every broker and/or Investment Advisor all follow the same rules.
6. Estate Planning Advantages
Not the most exciting benefit to highlight but an important one to consider in the unlikely event you should pass away. In that scenario, it’s more than likely that your 401k will be paid to your beneficiary in one lump sum, causing all kinds of income and inheritance tax issues. It depends on the plan but most companies prefer to distribute the cash fast so they aren’t stuck maintaining the account. Inheriting an IRA has regulations too, but IRAs offer more payout options. Like most of the other benefits, it all comes down to control.
7. Invest in Bitcoin and Digital Assets
While this is less of a benefit and more of a plug, IRAs allow you to invest in Bitcoin directly. Why does this matter? Bitcoin is one of the best non-correlated assets to include in any multi-asset portfolio, offering stronger returns and a better Sharpe and Sortino ratio despite its volatility. Because of current IRS tax treatment, investing Bitcoin is a non-qualified // traditional cash account can have pretty punitive tax consequences, especially if you plan on buying and selling over time. Owning an investment like Bitcoin that has high potential for asymmetric returns, especially in a Roth IRA, allows you to not only enjoy the long term benefits tax-free but avoid the punitive taxes on transactions. Should you want to invest Bitcoin directly in your 401k or IRA, DAiM can facilitate the process. Give us a call or send us a note to set up a free consultation.
Contribution limits per the most recent IRS guidelines in 2020 for 401k or 403b plans are $19,500. Catch up limits for individuals over 50 is $6,500. For IRAs, contribution limits are $6,000 with catch up limits an extra $1,000.
If you are switching jobs, there are a lot of benefits and advantages to rolling over your 401k to an IRA. Evaluate the details of both your old employer and new employers plan, including investment options, fees, loan provisions, etc.. Compare them to features and investment options offered in an IRA that you can establish with a broker or Investment Adviser. It's likely you’ll end up finding more choices, options and lower fees by rolling into the IRA. As an added bonus, you can give yourself the best of both worlds by rolling over all or some of your old 401k into an IRA and then contributing to both your new company’s 401k plan and your newly created IRA.
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