What’s a 401k Rollover – Should You Rollover Your 401k?

When you change jobs or retire, you have some options to consider for your 401k. You can transfer your 401k into an IRA, leave the money in the 401k, or cash it out. Transferring to an IRA is known as a 401k rollover, and is generally your best option. We’ll discuss what a 401k rollover would do for your retirement, and discuss whether it will be the best option for you.

What is a 401k Rollover?

A 401k rollover is when you move assets from your 401k to a traditional IRA. If you contributed to an after tax 401k, that money could be transferred to a Roth IRA instead.

IRAs an 401ks are pretty similar, and should be at the top of your hierarchy of savings. Both accounts are tax-deferred, meaning you will not have to pay capital gains taxes on selling investments or from dividends. Over time, this tax savings will really add up.

Both accounts allow you to take the money out without any penalties when you turn 59 1/2 years old.

Advantages of a 401k Rollover

While both 401ks and IRAs are similar from a tax perspective, IRAs offer several benefits over a 401k. The most significant benefit will be your investment choices. 401ks are notorious for offering a limit set of investments, and typically these have fees that are unreasonably high.

IRAs Have Lower Fees

We wrote in a previous article about how mutual funds rip off investors. Unfortunately, many 401k plans only offer mutual fund investments that offer incredibly high fees. These fees are an unnecessary tapeworm for retirees. Even Warren Buffett was called out during Berkshire Hathaway’s 2018 shareholder meeting because many of his employees are being charged unreasonably high fees for their 401ks.

IRAs Give You More Options

IRAs open up your investment choices. Any investment you want to make from your brokerage account, such as stocks, bonds, and ETFs can be purchased through your IRA. Your options will be unlimited, whereas a 401k only offers a few highly priced funds.

While we recommend sticking to an S&P 500 ETF, having options could be helpful if the S&P 500 becomes overvalued. You may want to invest in individual stocks as a hobby, or you may want to invest internationally since they are priced at a lower valuation. Having these options can never hurt.

IRAs Give You More Flexibility

IRAs are also more flexible than your 401k. You can use up to $10,000 of your IRA for a first time home purchase, and can spend as much as you want for college.

What if You Leave Your 401k Alone?

As long as your 401k account has enough value, you’re allowed to keep your money in your former employer’s 401k plan. If you’re happy with their investment options, you certainly could leave this as is.

With that said, we never see a scenario where this makes sense. By opening your investing options with an IRA, you’ll be able to save a ton in investment fees. As we previously wrote, $10,000 in mutual funds will cost you over $50,000 over 30 years.

The same logic applies to transferring your previous 401k to your new employer’s 401k. Although you certainly can do this, you’ll have fewer options and will definitely pay more in fees.

What if You Cash Out Your 401k?

Unless you’re in extreme financial hardship, you should not cash out your 401k under any circumstance. You’ll be hit with taxes and early withdrawal penalties, which could easily take 35% of your nest egg. Finally, that money will now be assessed with capital gains and dividends taxes if you reinvest the money. As we explained in our hierarchy of savings, this should be the last place your extra money goes.

401k – The Bottom Line

Under just about every circumstance, you should roll your 401k over to an IRA. You’ll save a ton in fees, you’ll have far more investment options, and more flexibility with this money.

Even if your previous 401k had reasonable fees, you can certainly find lower priced options in the open market with your IRA. 401k fees in general are far too high – the sooner you can escape those costs, the more you’ll have when you retire.