Financial Planning
back
In 2023, around 25 million households had IRAs that included assets rolled over from their former employer plans, according to the Investment Company Institute. Still, companies are increasingly encouraging departing employees to leave their retirement savings in the employer plan. According to data from Vanguard Group, almost half of plan participants who left their employers last year retained the money in their 401(k) plans, and about a quarter of job leavers age 60 and over still had money in their former company’s 401(k) plan five years after leaving.
The decision needs to be considered carefully, given that there are important, but little appreciated, consequences that flow from each choice. A recent study I conducted with John Turner and Catherine Reilly covered some of the key considerations driving this decision. Here is a look at the advantages of each option.
You’ll likely have more investment options.
One of the primary benefits of rolling over a 401(k) into an IRA is access to a larger menu of investment options. IRAs typically provide more choices than available in a 401(k) plan, including exchange-traded funds. Some ETFs charge relatively low fees, particularly index ETFs, yet relatively few employer-sponsored retirement accounts include these products to date.
In addition, a retiree seeking to buy individual stocks and bonds could do so in an IRA, as 401(k) plans tend to favor mutual funds (some do allow access to individual investments via brokerage accounts). And IRAs can hold “unconventional” assets, including precious metals, physical real estate and hedge funds—investments not typically included in employer-sponsored plans.
You can streamline your accounts.
People with several 401(k) accounts from past employers can streamline their financial lives by rolling them all into one IRA. This can make it easier to manage your portfolio and track your investments. And you won’t need to dredge up various account numbers and passwords.
It is true that most 401(k) plans allow you to roll retirement savings from past employers into your current 401(k). Still, if you also have money in an IRA, that money will still remain separate.
Streamlining the number of retirement accounts also can simplify finances for your spouse or children, when the time comes for them to help you with important decisions about eldercare, nursing homes and estate management. This also can matter when the time comes for them to deal with your estate. When my own elderly parents died, for instance, it took me an entire year to sort out and consolidate their various (small) financial accounts.
You’ll typically have more flexible payouts.
IRAs usually offer more flexible payout options than 401(k)s. For instance, your former employer may restrict how much, and how often, you can withdraw from your 401(k) account, and whether the amounts withdrawn can vary over time.
Investor's reasons for rolling over a 401(k)
By contrast, retirees can withdraw what they like from their IRAs, without needing to demonstrate hardship to take a distribution. Note that IRA distributions must be included in taxable income, and a 10% tax penalty applies for withdrawals made before age 59½.
With an IRA, you also can purchase an annuity that will generate a steady income stream for life, while few 401(k) plans currently include payout annuities in their investment menus. This is changing, however, as rules under the Secure Act and Secure 2.0 Act now allow plan sponsors to embed payout annuities into 401(k) menus, and several companies are moving to offer such products.
An additional consideration is that some financial advisers might be biased against offering lifetime income products in IRAs, when they can earn higher commissions by steering clients away from annuities. This may be less of a problem in the future, given a new rule from the Labor Department that requires anyone giving rollover advice to act in the saver’s best interest. This rule does face challenges from insurance associations and adviser advocacy groups, however, who argue that it will make it more difficult for clients to obtain annuity products.
Your costs and investment fees could be lower.
Employer-sponsored 401(k) plans tend to offer less-costly pricing on investments and advice, compared with IRAs. For this reason, leaving assets in the company retirement plan could help retirees earn more on their investments.
For instance, our study reported that retirees covered by a large employer plan (with more than $1 billion in assets) who move the money into an IRA could pay an additional 0.35% of assets under management in investment administration fees each year. The typical employer plan would charge between 0.20% and 0.25% of assets annually to cover adviser fees, compared with 1% of assets in the IRA. Those lower fees could wipe out any advantage you might get from investing in lower-cost ETFs through an IRA, depending on how much of your money is in those ETFs.
Robo advisers do charge less—from a quarter to a half percent of assets under management per year—and these can be a good option for those with smaller accounts. Yet they also tend to offer a narrower range of investment options.
Most 401(k) plans are likely to offer access to low-cost target-date funds that automatically adjust the investment mix as participants age. As a result, older plan participants are automatically moved into safer holdings as they age, without having to take any proactive steps (in contrast to IRAs). Yet even here, overall costs can differ across employer plans, so it is crucial to do your own comparisons.
Another point in favor of the 401(k) is that employers are increasingly working to hold on to 401(k) accounts, even after their employees retire. They do so to benefit from economies of scale and, hence, lower costs for all participants, both active and retired. Larger companies, in particular, can negotiate lower fees from record-keepers and money managers, something IRA investors are not likely to be able to do on their own.
You have greater fiduciary protections.
Keeping your retirement money in your 401(k) plan provides a level of fiduciary protection not offered by many financial advisers. That’s because the company offering the 401(k) must legally act in the best interests of plan participants. Specifically, employers are legally required to oversee plan investment choices and costs for retirees remaining in their 401(k) plans.
Meantime, fiduciary regulations for independent advisers assisting the IRA-rollover decision remain in flux.
A related factor is that 401(k) assets are legally protected from bankruptcy claims, while IRA money isn’t. This should be an important consideration for anyone potentially facing a financial setback in later life.
You can tap the money sooner.
For people needing to access their retirement assets sooner rather than later, 401(k)s often offer an important advantage. This is because many employer-sponsored plans will let you withdraw 401(k) money as early as age 55 without paying a penalty. For IRAs, the earliest access age without a tax penalty is 59½.
Another feature that I and many other older employees find attractive is the fact that we can delay taking required minimum distributions from our 401(k)s as long as we continue working for the employers offering the plans, while deferring income tax. IRAs, by contrast, require older workers to pull money out starting at age 72 (or age 73 if you reach age 72 after Dec. 31, 2022.)
Also, some employers allow retirees who leave their money in the plan to take 401(k) plan loans, giving them access to quick cash without having to pay withdrawal penalties or pay tax on the withdrawal right away.
You won’t be overwhelmed with options.
An abundance of investment choices can overwhelm the majority of retirees who aren’t financially literate, leading some to make poor investment and spending decisions. For example, my past research documented that many people age 50 and over don’t understand the basic principles of risk diversification, asset valuation, portfolio choice and investment fees. And, my research has showed, the most vulnerable to such shortfalls are women, the less-educated, nonwhites, and persons age 75 and over, who often have less retirement savings.
For such individuals, the relative simplicity of sticking with the 401(k) would be preferred, versus rolling over into an IRA.
IRA holders typically bear the responsibility of managing their own money, including monitoring the tax consequences of trading esoteric assets. Therefore, financially unsophisticated retirees holding unusual assets could face more complicated tax situations in IRAs, particularly if they don’t work with a tax specialist.
One other important factor for old workers to consider when deciding between the two options is estate planning—and the rules regarding what happens to retirement savings at death.
The money in your IRA will pass to your named beneficiary, if you have nominated someone, or to your estate if no beneficiary is named. With a 401(k), at least half of all assets remaining in a plan at the retiree’s passing must go to a surviving spouse (if any), unless the retiree provided written permission for the money to go to someone else. Whether this is an advantage depends on your marital situation and preferences.
Moreover, a nonspouse who inherits a 401(k) account must generally receive (and pay taxes on) the remaining money within 10 years. If a retiree doesn’t name a beneficiary on the 401(k) account and has no surviving spouse, the assets will likely be included in your estate and go to probate, which could be complex and often costly.
In the end, for most people, the choice should depend on how financially literate they are, how much money they have saved in their 401(k), how the alternatives are structured and their cost.
People with larger account balances may value the diverse investment options provided by IRAs, whereas savers with smaller retirement balances may do better sticking with their 401(k), given their potentially lower costs and fiduciary protections.
People in costly 401(k) plans are likely to do better by rolling over to IRAs, while retirees in larger, lower-cost 401(k) plans are likely to have an adequate investment menu if they stay with their plans. They also will pay lower management costs, benefit from the employer fiduciary shield, and appreciate the bankruptcy protection.
Most important, this crucial financial decision shouldn’t to be taken lightly. After all, it’s your hard-earned savings at stake.
Corrections & Amplifications: IRAs require older workers to pull money out starting at age 72 (or age 73 if you reach age 72 after Dec. 31, 2022). An earlier version of this article didn’t clarify that you had to reach age 72 after Dec. 31, 2022. (Corrected Aug. 11)
Olivia S. Mitchell is the International Foundation of Employee Benefit Plans professor of insurance/risk management and business economics/policy at the Wharton School of the University of Pennsylvania. She can be reached at [email protected].
What Should You Do With Your 401(k) When You Retire?
The decision needs to be considered carefully, given that there are important, but little appreciated, consequences that flow from each choice. A recent study I conducted with John Turner and Catherine Reilly covered some of the key considerations driving this decision. Here is a look at the advantages of each option.
Rolling over to an IRA
You’ll likely have more investment options.
One of the primary benefits of rolling over a 401(k) into an IRA is access to a larger menu of investment options. IRAs typically provide more choices than available in a 401(k) plan, including exchange-traded funds. Some ETFs charge relatively low fees, particularly index ETFs, yet relatively few employer-sponsored retirement accounts include these products to date.
In addition, a retiree seeking to buy individual stocks and bonds could do so in an IRA, as 401(k) plans tend to favor mutual funds (some do allow access to individual investments via brokerage accounts). And IRAs can hold “unconventional” assets, including precious metals, physical real estate and hedge funds—investments not typically included in employer-sponsored plans.
You can streamline your accounts.
People with several 401(k) accounts from past employers can streamline their financial lives by rolling them all into one IRA. This can make it easier to manage your portfolio and track your investments. And you won’t need to dredge up various account numbers and passwords.
It is true that most 401(k) plans allow you to roll retirement savings from past employers into your current 401(k). Still, if you also have money in an IRA, that money will still remain separate.
Streamlining the number of retirement accounts also can simplify finances for your spouse or children, when the time comes for them to help you with important decisions about eldercare, nursing homes and estate management. This also can matter when the time comes for them to deal with your estate. When my own elderly parents died, for instance, it took me an entire year to sort out and consolidate their various (small) financial accounts.
You’ll typically have more flexible payouts.
IRAs usually offer more flexible payout options than 401(k)s. For instance, your former employer may restrict how much, and how often, you can withdraw from your 401(k) account, and whether the amounts withdrawn can vary over time.
Investor's reasons for rolling over a 401(k)
- Didn't want to leave assets with former employer - 66%
- To consolidate assets - 61%
- More investment options - 59%
- To preserve tax treatment of savings - 57%
- Required to take all money out of former emploer's plan - 44%
- Wanted to keep assets with the same financial-services provider - 43%
- Wanted to use a differnet financial services provider - 41%
- Told by a financial advisor to roll over assets - 30%
- Thought it was easier to roll over assets to an IRA than into new employer's plan - 27%
- Wanted the same investments that were in the former emploer's plan - 9%
Source: Investment Company Institute IRA Owners Survey
By contrast, retirees can withdraw what they like from their IRAs, without needing to demonstrate hardship to take a distribution. Note that IRA distributions must be included in taxable income, and a 10% tax penalty applies for withdrawals made before age 59½.
With an IRA, you also can purchase an annuity that will generate a steady income stream for life, while few 401(k) plans currently include payout annuities in their investment menus. This is changing, however, as rules under the Secure Act and Secure 2.0 Act now allow plan sponsors to embed payout annuities into 401(k) menus, and several companies are moving to offer such products.
An additional consideration is that some financial advisers might be biased against offering lifetime income products in IRAs, when they can earn higher commissions by steering clients away from annuities. This may be less of a problem in the future, given a new rule from the Labor Department that requires anyone giving rollover advice to act in the saver’s best interest. This rule does face challenges from insurance associations and adviser advocacy groups, however, who argue that it will make it more difficult for clients to obtain annuity products.
Sticking with your 401(k)
Your costs and investment fees could be lower.
Employer-sponsored 401(k) plans tend to offer less-costly pricing on investments and advice, compared with IRAs. For this reason, leaving assets in the company retirement plan could help retirees earn more on their investments.
For instance, our study reported that retirees covered by a large employer plan (with more than $1 billion in assets) who move the money into an IRA could pay an additional 0.35% of assets under management in investment administration fees each year. The typical employer plan would charge between 0.20% and 0.25% of assets annually to cover adviser fees, compared with 1% of assets in the IRA. Those lower fees could wipe out any advantage you might get from investing in lower-cost ETFs through an IRA, depending on how much of your money is in those ETFs.
Robo advisers do charge less—from a quarter to a half percent of assets under management per year—and these can be a good option for those with smaller accounts. Yet they also tend to offer a narrower range of investment options.
Most 401(k) plans are likely to offer access to low-cost target-date funds that automatically adjust the investment mix as participants age. As a result, older plan participants are automatically moved into safer holdings as they age, without having to take any proactive steps (in contrast to IRAs). Yet even here, overall costs can differ across employer plans, so it is crucial to do your own comparisons.
Another point in favor of the 401(k) is that employers are increasingly working to hold on to 401(k) accounts, even after their employees retire. They do so to benefit from economies of scale and, hence, lower costs for all participants, both active and retired. Larger companies, in particular, can negotiate lower fees from record-keepers and money managers, something IRA investors are not likely to be able to do on their own.
You have greater fiduciary protections.
Keeping your retirement money in your 401(k) plan provides a level of fiduciary protection not offered by many financial advisers. That’s because the company offering the 401(k) must legally act in the best interests of plan participants. Specifically, employers are legally required to oversee plan investment choices and costs for retirees remaining in their 401(k) plans.
Meantime, fiduciary regulations for independent advisers assisting the IRA-rollover decision remain in flux.
A related factor is that 401(k) assets are legally protected from bankruptcy claims, while IRA money isn’t. This should be an important consideration for anyone potentially facing a financial setback in later life.
You can tap the money sooner.
For people needing to access their retirement assets sooner rather than later, 401(k)s often offer an important advantage. This is because many employer-sponsored plans will let you withdraw 401(k) money as early as age 55 without paying a penalty. For IRAs, the earliest access age without a tax penalty is 59½.
Another feature that I and many other older employees find attractive is the fact that we can delay taking required minimum distributions from our 401(k)s as long as we continue working for the employers offering the plans, while deferring income tax. IRAs, by contrast, require older workers to pull money out starting at age 72 (or age 73 if you reach age 72 after Dec. 31, 2022.)
Also, some employers allow retirees who leave their money in the plan to take 401(k) plan loans, giving them access to quick cash without having to pay withdrawal penalties or pay tax on the withdrawal right away.
You won’t be overwhelmed with options.
An abundance of investment choices can overwhelm the majority of retirees who aren’t financially literate, leading some to make poor investment and spending decisions. For example, my past research documented that many people age 50 and over don’t understand the basic principles of risk diversification, asset valuation, portfolio choice and investment fees. And, my research has showed, the most vulnerable to such shortfalls are women, the less-educated, nonwhites, and persons age 75 and over, who often have less retirement savings.
For such individuals, the relative simplicity of sticking with the 401(k) would be preferred, versus rolling over into an IRA.
IRA holders typically bear the responsibility of managing their own money, including monitoring the tax consequences of trading esoteric assets. Therefore, financially unsophisticated retirees holding unusual assets could face more complicated tax situations in IRAs, particularly if they don’t work with a tax specialist.
Other considerations
One other important factor for old workers to consider when deciding between the two options is estate planning—and the rules regarding what happens to retirement savings at death.
The money in your IRA will pass to your named beneficiary, if you have nominated someone, or to your estate if no beneficiary is named. With a 401(k), at least half of all assets remaining in a plan at the retiree’s passing must go to a surviving spouse (if any), unless the retiree provided written permission for the money to go to someone else. Whether this is an advantage depends on your marital situation and preferences.
Moreover, a nonspouse who inherits a 401(k) account must generally receive (and pay taxes on) the remaining money within 10 years. If a retiree doesn’t name a beneficiary on the 401(k) account and has no surviving spouse, the assets will likely be included in your estate and go to probate, which could be complex and often costly.
In the end, for most people, the choice should depend on how financially literate they are, how much money they have saved in their 401(k), how the alternatives are structured and their cost.
People with larger account balances may value the diverse investment options provided by IRAs, whereas savers with smaller retirement balances may do better sticking with their 401(k), given their potentially lower costs and fiduciary protections.
People in costly 401(k) plans are likely to do better by rolling over to IRAs, while retirees in larger, lower-cost 401(k) plans are likely to have an adequate investment menu if they stay with their plans. They also will pay lower management costs, benefit from the employer fiduciary shield, and appreciate the bankruptcy protection.
Most important, this crucial financial decision shouldn’t to be taken lightly. After all, it’s your hard-earned savings at stake.
Corrections & Amplifications: IRAs require older workers to pull money out starting at age 72 (or age 73 if you reach age 72 after Dec. 31, 2022). An earlier version of this article didn’t clarify that you had to reach age 72 after Dec. 31, 2022. (Corrected Aug. 11)
Olivia S. Mitchell is the International Foundation of Employee Benefit Plans professor of insurance/risk management and business economics/policy at the Wharton School of the University of Pennsylvania. She can be reached at [email protected].
