Should I Roll Over My 401k into an IRA? How to Decide

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The WSJ article What to Do With a 401(k) When Leaving a Job did a good job summarizing the various things to consider when that time comes. Here is a chart showing what happens to the 401k and 403b plans held across Vanguard-sponsored employer plans:

Now, Vanguard-sponsored 401k plans are mostly from big employers and are highly likely to have both low-cost investment options and reasonable fees. I don’t know if these percentages apply to all 401k and 403b plans in general. I’ve seen some pretty bad ones with absurdly high fees, although that was several years ago. Here’s a summary of the right questions to ask:

Investment selection? Are the available investments better in your 401k or in your choice of IRA custodian? Some 401ks offer choices not available to retail investors. For example, access to mutual funds from Dimensional Fund Advisors (DFA). Or institutional shares of certain funds with low expense ratios. Or stable value funds with higher interest rates than retail bond funds. On the other side, you may be itching to buy something like real estate in a self-directed IRA. These days, both probably have some sort of all-in-one Target retirement fund, but is yours a low-cost option from Vanguard (Target Retirement) or Fidelity (Freedom Index)?

Account fees? Part of the total cost picture is the expense ratio of the funds inside, but you may also be subject to overall account management fees or maintenance fees. Some 401k plans have zero or minimal management fees. Other 401k plans have crazy-high fees on the order of 1.75% of assets annually. Nearly all of the major IRA providers now offer no annual fees and commission-free ETF trades.

Need Advice? Some 401k plans offer some level of included advice that you may value. Other people have their own personal advisor that would love to customize that IRA.

Age 55 Rule (Early withdrawal?). Starting in the year that you turn 55, you can make a withdrawal from your 401k without the 10% early withdrawal penalty. You will still owe income taxes for a pre-tax 401k withdrawal, just not 10% penalty. For IRAs, you would have to wait until age 59.5. Potential early retirees may value these 4.5 years of additional flexibility.

Asset protection needs? There is a lot of legal fine print here, but 401k plans in general appear to offer some of the highest levels of asset protection. IRAs do offer a certain level of asset protection as well, just not quite as high as a 401(k). The difference will probably not matter much for the vast majority of workers, but it may matter for high-income professionals with liability concerns like doctors.

Non-deductible / Backdoor IRA contributions? The article didn’t cover why I didn’t roll over my last 401k plan into an IRA when leaving the employer. My situation is admittedly somewhat uncommon, but not unheard of. Call it “finding-yeast-in-April-2020” uncommon.

Due to my higher income level at the time, I contributed to a non-deductible IRA each year and then converted that to a Roth IRA. (This is also known as a Backdoor Roth IRA.) However, when you do the conversion, if you have any other pre-tax “traditional” IRAs, your conversion must include the pre-tax IRA amount as well on a pro-rated basis. For example, if you had a $20,000 pre-tax deducted IRA and a $5,000 non-deductible IRA, and then decided to convert $5,000 into a Roth IRA it would be considered 80% from the pre-tax IRA and only 20% non-deductible. You’d have to pay taxes on the entire pre-tax IRA amount (contribution + gains) since you never paid taxes initially. By keeping my pre-tax 401k at the employer, I am able to take full tax advantage of all annual Backdoor Roth contributions. Thankfully, the old 401k was at Fidelity with solid investment options and no annual fees.

How much do you value simplicity? If you do a lot of job-hopping, then do you really want to juggle five old 401k accounts? Merging them all into one IRA can save you time and hassle. On top of keeping tabs on your investments and asset allocation, you’d have to do all the mundane things like keep all your contact info and beneficiaries up to date. I would worry also that my spouse would forget about an old 401k plan if I something happened to me.

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  1. One thing that has stopped me from rolling over my previous employment’s 401k balance to my IRA is timing. It takes nearly a week to complete the sale at the 401k company and purchase at the IRA company. Meanwhile, especially now, the stock market could rise significantly while my money is out of the market.

    I guess I could do small chunks at at time over several months to dollar cost average, but the paperwork is so tedious.

    • That’s true, I put off rebalancing in March because of these crazy swings. You could rebalance and then something changes by 5% in a day! (It would have made me some money, though, in retrospect.)

  2. One factor you’re not considering is asset-based relationship pricing. I recently got .25 off my mortgage rate due to assets I was able to move over to that bank. If I hadn’t been rolling my wife’s 401k to her new 401k, but instead rolled to an IRA, we could have hit the next tier and saved an additional .125 in rate. In my example, that costs me $60 a month for 30 years.

    • Good point, especially in the current environment when every bank and broker is competing for assets under management. Saving 0.375% off the best market rate, that’s a big savings!

  3. Jonathan,

    That’s a great article. I think that you have included great commentary, and added some from your own personal experience that was not listed by WSJ article.

    The problem with 401 (k) plans is the difficulty of rolling from one 401 (k) to another. The process is very archaic. I have to A) liquidate an old 401 (k), B) then have the custodian mail a check to me, C)which I then have to send and D) deposit to the new custodian. This can take a few weeks, during which I am not invested, and a potentially large 5 or 6 figure check is being bounced around the country.

    I do not like keeping money in IRA’s due to the IRA conversion issues mentioned here and the higher level of asset protections that 401 (k) assets offer. Plus, being able to access funds at 55 is just for the 401 (k) at your last job for which you retired at 55. It doesn’t affect old 401 (k) – which is why it may make sense to consolidate them.

    • I’m definitely surprised that 15+ years after my first 401k rollover, the process sounds the same with a snail mail check.

      I’m also a bit surprised you wouldn’t prefer the IRA, as you could own individual stocks instead being limited to the mutual fund selection of the 401k.

      Thanks for the important clarification on the age 55 rule!

      • It makes sense to sign up for a 401 (k) since I don’t want to miss out on the match. It’s part of total compensation.

        I don’t mind owning funds for a portion of my total net worth. I view S&P 500 as a giant dividend growth stock with 500 subsidiaries. By the end of 2019 it was a dividend achiever in itself, though perhaps not in 2020 😉 It offers diversification in companies I may not have otherwise selected.

        Some 401 (k) plans offer a brokerage window that let you buy stocks, bonds, etf’s, so you have a lot more flexibility.

        I really do like asset protection of a 401 (k) however.

  4. Good write up. Thanks for the info. Have you ever looked into a Solo 401k? Was thinking you could move old 401k’s into a Solo 401k and still avoid the issue with Roth conversations.

    • Also a good point. I believe it would have to depend on the specific Plan Documents, but I think most Solo 401k plans should be able to accept an incoming 401k rollover. I guess I just skipped over that possibility since most people don’t have a Solo 401k and it is basically like rolling over to any other new job 401k.

  5. I moved from an employer 401K since the fees were horrendous. Self managed was easy peasy and no fees.

  6. Jonathan,

    I would like to second what John R said. Migrating 401K is extremely tedious and long process. It took nearly 2 months in my case.

    You mentioned some funds have ridiculous expense ratio. I am using FeeX to compare cost between vanguard target fund vs. My cur re nt employer Trow price target fund and saw nearly .7% in difference (
    .14% vs. .84%). Does this mean I should move all my 401K fund in vanguard? Am I missing anything else?

    • TRP Target funds are actively managed, and thus have a higher expense ratio. Their recent historical relative performance has actually been pretty good partly because of their relative slightly higher stock exposure during the recent bull market and their relatively small amount of international stock exposure. I think TRP is a reputable firm and not a rip-off, but you would just have to decide if you want to pay the somewhat higher expenses in the hope of continued outperformance. If I had to choose, I would personally pick Vanguard, but I wouldn’t be angry if my only choice was a TRP target fund.

  7. I’ve never moved a 401K, as I’ve been at the same employer for most of my career, I have however moved investments, mutual funds, and IRA from one brokerage to another, and have also converted an IRA to a Roth IRA. Moving investments does take time, and I wish the process were easier. Some investments do not translate, and can’t be moved ‘in kind’ which means you may have to start all over again. For the Roth IRA conversation, you have to pay taxes. Whether or not movement or conversion is best for you, I think it depends on your situation. I would seriously consider moving my 401K to an IRA if I were to leave my job, as my 401K has lousy investments– approximately 12 with high fees. On my own, investing at a brokerage, I believe I’m at -2% for the year, where my Roth IRA is at -10% and my 401K is currently at -28%. All are diversified, but I have a greater range of investment options in my brokerage and IRA, and my IRA is more conservative. I also pay significantly less fees in my brokerage and Roth IRA.

    You mention being able to tap your 401K at 55, so there’s the rule of 55 and the 72(t), but you have to no longer be with your employer on the year you turn 55 or older, and I believe you have to take out equal payments until 59 1/2 if you do so. At least if I understand it correctly…

    Anyway, what might be a strategy would be to save money in a brokerage that you can tap at any time, vs in a retirement account. Granted this is post tax. It might give you a cushion you can use until you can access your retirement account(s).

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