When to roll over 401k to an IRA (Individual Retirement Account)?
When you lose a job, change or job or just quit a job, you should at least give a thought on what to do with your retirement savings, such as a 401(k) account in your employer sponsored retirement plan.You can have there choices:
- Stay in the same plan: regardless whether you are fired, laid off or just leave voluntarily, you can opt to keep your 401(k) account in the same plan.
- Rollover to your new employer-sponsored plan: supposed your new employer sponsors a retirement plan, you can choose to move (rollover) your 401k account to your new employer’s.
- Rollover to a self-directed IRA: Or you can choose to move your 401(k) account to a so called Individual Retirement Account (IRA) in a brokerage such as Fidelity or Schwab. Virtually all major brokerages these days support and welcome IRAs.
Notice that if you don’t experience any job change, IRS doesn’t allow you to rollover your 401(k) to other plans.
So what are the pros and cons to rollover a 401k to an IRA?
Pros of Moving to a Self-Directed IRA
Pros of Moving to a Self-Directed IRA:
Enhanced Investment Choices
- Access to a Broad Range of Investments: With a self-directed IRA, investors have the opportunity to choose from a wide array of investment options, including ETFs and thousands of no-load, no-transaction-fee mutual funds. This is in contrast to a typical 401(k) plan, which usually offers a limited selection of around a dozen mutual funds. The expanded investment choices in an IRA provide investors with greater flexibility to tailor their portfolio to their specific investment goals and preferences.
Lower Costs
- Ultra-Low Cost Index Mutual Funds and ETFs: Many investment funds available in self-directed IRAs are ultra-low-cost index mutual funds or ETFs. These funds aim to replicate the performance of a specific market index, such as the S&P 500, and generally have lower expense ratios compared to actively managed mutual funds. By choosing low-cost investment options, investors can potentially reduce their investment expenses and retain a larger portion of their investment returns over the long term.
- No Administration Fee: Unlike a 401(k) account, which often comes with administrative fees, self-directed IRAs typically do not have an administration fee associated with them. This can result in cost savings for investors and contribute to the overall growth of their retirement savings.
Flexibility in Asset Allocation
- Diversification Opportunities: Self-directed IRAs offer the opportunity to diversify investments beyond traditional stocks and bonds. Investors can explore alternative asset classes, such as real estate, precious metals, private equity, and more. Diversification helps spread investment risk and can potentially enhance overall portfolio performance.
- Alignment with Financial Goals and Risk Tolerance: By having a broader range of investment options, individuals can align their asset allocation with their financial goals and risk tolerance. They have the flexibility to choose investments that suit their individual circumstances, investment objectives, and preferred risk levels.
Potential for Higher Returns
- Capitalizing on Investment Opportunities: With the expanded investment choices available in a self-directed IRA, investors can capitalize on a wider range of investment opportunities. By carefully selecting investments that align with their strategies and market trends, they have the potential to achieve higher returns compared to more limited options in a 401(k) plan.
- Access to Alternative Investments: Self-directed IRAs provide access to alternative investments, which can have the potential for significant returns. These investments may include real estate, private equity, venture capital, or other non-traditional assets. Exploring these alternative opportunities can unlock additional growth potential and diversify investment portfolios.
Cons of Moving to a Self-Directed IRA
Increased Responsibility
While self-directed IRAs offer exciting possibilities, they also come with increased responsibility. Investors need to be fully aware of regulations if adopting some alternative investments such as investing in gold or commodities. They might also lose helps that a 401(k) plan might offer.
Heightened Risks
Adopting various investment strategies and having access to many funds and types of investments also mean higher chances of making mistake. investors might be tempted to try too many different strategies without fully understanding their risk and behavior. Furthermore, .if alternative investments are adopted (such as investing in Gold, commodities), they tend to have higher volatility and full of speculation.
Loss of some special investment funds
Even though in general, a brokerage offers many more investment fund choices for an IRA, there are some funds that might not be available in an IRA. These include 1). closed to new investor funds. For example, T.Rowe Price Capital Appreciation fund has been closed to new investors since 2017, however, for those 401(k) plans that have offered the fund, investors in those plans can still invest in that fund. 2). many funds are only available in a retirement plan or through an investment advisor. A famous example is the Dimensional Funds that are only available through investment advisors and in some 401(k) plans.
To summarize, if you are an experienced investor or you are ready to be more disciplined, it’s in general better to rollover to an IRA when given a chance. However, if your existing 401(k) offers some features and funds that you don’t want to miss, you might want to make a careful decision.