Rolling over to an IRA vs. retaining an employer retirement plan

The average worker in the U.S. today will hold 10 different jobs before the age of 40, according to the Bureau of Labor Statistics. And that figure is expected to grow in the years ahead. If you’re among the 64% of Americans with access to a defined contribution retirement plan—commonly known by its IRS designation as a 401(k), or in some cases a 403(b) or 457(b)—through your employer, this means you’ll likely face this decision several times throughout your life: What should I do with my existing plan?

When you’re leaving a job with a retirement plan—or considering what to do with an older account you’ve held onto—you have 4 options:

• Roll over to your new employer’s plan. If you’re moving to a new job that offers a retirement plan and allows you to roll in existing assets, it’s worth getting the details before you decide—you may find extremely low fees or attractive investment options.
• Roll over to an IRA. This option lets you preserve the tax advantages of your old plan and access a wide range of investment options. Plus, many people find that combining their retirement savings accounts into one place makes it easier to manage their money and track their progress.
• Cash out. There could be significant drawbacks with this option, so before cashing out, ask yourself whether you urgently need the money. If you’re under 59½, you could be subject to a 10% early withdrawal penalty from the IRS and will likely owe income tax on the money you withdraw. Note: The 10% penalty won’t apply if you’ve left your job at age 55 or older (age 50 in some public service jobs).
• Leave your plan in place. If you’re not ready to make the decision, staying put is an option. You can always choose to roll over into an IRA or another employer plan later. Just be aware of any possible restrictions or downsides to retaining your 401(k) plan. How much access to the plan administrator will you have as a nonemployee? Are there maintenance fees involved? You won’t pay taxes on the 401(k), but as a former employee, you can no longer make contributions to the plan. And if your balance is under $5,000, your employer can distribute it without your consent, so you’ll want to have a plan in place.

Choosing a rollover IRA can potentially bring you many benefits: reduced costs, consolidation, a wider range of investment options, and tax advantages. But you should keep some particulars in mind as you weigh the decision.

Investment options and flexibility

Most 401(k)s offer a relatively limited menu of core options. The investment options are determined by your employer and the type of plan it offers. If your plan includes a specific investment that isn’t available through an IRA and is integral to your investment strategy, that may be a reason for you to stay put.

By contrast, when you open an IRA, the investment options are practically unlimited.

“With an IRA, the world is your oyster,” says Lobel. “There are thousands of low-cost ETFs and mutual funds from which to choose.” That’s in addition to individual stocks, CDs, and other investment vehicles.

Lobel cautions that “for some people, more choice can be overwhelming.” But with a bit of research, you can find the right investments to match your goals and give you the diversification that’s key to investment success.

Tax advantages

The great advantage of traditional 401(k)s and IRAs is the ability to defer taxes until you reach retirement. When you roll from a 401(k) plan to a rollover IRA, you maintain that benefit and keep saving for the future while your money continues to grow tax-deferred.

You can also roll your 401(k) into a Roth IRA, if you’re looking for more flexibility, but be aware you’ll have to pay taxes upfront if you do. (With a Roth IRA, you pay taxes on your initial contributions but not at the time you withdraw.) If you already have Roth accounts within your 401(k) plan, you’ll need to roll those into a Roth IRA, but you won’t have to pay taxes.

Pro tip: If you’ve made after-tax contributions to your 401(k), there’s a distinct advantage to rolling those funds over to IRAs. Your after-tax contributions would roll to a Roth IRA—as of now, although proposed policy changes could remove this option in the future—and your tax-deferred earnings would roll to a traditional IRA. Rolling after-tax contributions to a Roth IRA unlocks the advantage of tax-free growth on those assets, instead of deferring the taxes if you were to leave your old 401(k) plan in place or roll your investments into a new employer plan.

Notes:

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss.

There are important factors to consider when rolling over assets to an IRA or an employer retirement plan account, or leaving assets in an employer retirement plan account. These factors include, but are not limited to, investment options in each type of account, fees and expenses, available services, potential withdrawal penalties, protection from creditors and legal judgments, required minimum distributions, and tax consequences of rolling over employer stock to an IRA.

We recommend that you consult a tax or financial advisor about your individual situation.

Vanguard Personal Advisor Services and Vanguard Digital Advisor’s services are provided by Vanguard Advisers, Inc. (“VAI”), a federally registered investment advisor. VAI is a subsidiary of The Vanguard Group, Inc. (“VGI”), and an affiliate of Vanguard Marketing Corporation. Neither VGI, VAI, nor its affiliates guarantee profits or protection from losses. For more information on the services, see Form CRS and the Vanguard Personal Advisor Services Brochure and Form CRS and the Vanguard Digital Advisor Brochure.

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