When you leave an employer, it’s often tempting to immediately roll your 401k balance over to a traditional IRA, either to consolidate retirement assets or merely to cut the final tie to your old company. Although you can benefit from this urge in many situations, rolling over isn’t a universally wise investment strategy. Before you close down an old 401k, it’s important to understand that rollovers can have disadvantages.
Advantage: Portfolio Management
Even the most broadly structured 401k doesn’t allow you to invest across the market. Moving 401k assets to an IRA provides literally limitless investment possibilities. Because brokerages create IRA products to suit nearly all investment strategies, you’re more likely to find a managed account better tailored to your investment style, or one in which you can balance your portfolio, than the one managed for your employer. If you’re more of a hands-on investor, you can manage trades within your IRA’s brokerage fund, putting you in complete control of your retirement investments.
Disadvantage: Loss of Loan Option
Once you place money in an IRA, the Internal Revenue Service allows penalty-free distributions for only a handful of circumstances, all based on financial hardship. So unless you rack up large medical bills, or you need to avoid foreclosure, or you purchase your first home or you become disabled, assets in IRAs aren’t emergency-fund-friendly. Many 401ks allow investors to take out loans from their account balance. The IRS lets investors to take up to $50,000 in loans, though your plan’s rules may set the limit lower. The loan is then repaid by the investor, with interest added to the value. Many plans allow you to make self-financed loans without many conditions to qualify.
If you’re like most Americans, you’ll work for several employers throughout your career. With each change of workplace, it’s likely you’ll receive a different set of retirement options, and you might end up with assets in several 401ks of former employers. Although most plans allow new employees to roll over old 401k balances into a new plan, it’s a process you’ll need to repeat – and you might encounter a poorly administered plan sometime in your career. Rather than maintain small balances in several outdated 401k plans, many investors choose rollovers for the simplicity that comes with holding all retirement assets in one brokerage’s IRA products.
You and your former co-workers probably formed an investment collective that helped your employer negotiate lower maintenance and transaction fees for your 401k, based on the volume of money invested in the plan. As an individual investor, you’re unlikely to receive such favorable treatment from brokerage. So a rollover could end up costing you more for essentially the same investments.
Advantage: Estate Planning
If your portfolio is large enough to support you in retirement without the need to tap traditional IRA assets, multigenerational IRAs can allow your pretax earnings to continue compounding returns long after your death. Naming a younger beneficiary, such as your child, delays the distribution schedule in case you die before you exhaust the IRA, allowing it to compound returns until your child reaches retirement age.
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