An important question in your retirement journey is, “should I roll over my 401k to an IRA or leave it in my employer’s plan”? This decision can be triggered due to finding a new job, being laid off, or retiring.
While it seems straightforward, there are several important factors to consider when deciding whether to roll over your 401k to an IRA or leave it with your former employer.
The generic advice has typically been to roll over your 401k to an IRA when you leave your employer. This is well intentioned advice. As an advisor I would often see clients with multiple almost forgotten 401ks from long ago employers, usually inappropriately invested. Sometimes all of the funds would be in cash! By consolidating these various retirement accounts into one IRA and investing in a portfolio in alignment with the client’s financial plan significant value can be added.
The decision to roll over your 401k or leave it at your employer is one of those decisions where the general financial advice may not apply to your personal situation. Before deciding to roll over your 401k several factors should be considered.
Factors To Consider Before Rolling Over Your 401k
1. Rule of 55
If you are 55 or older when you leave your firm, you can usually withdraw money from your 401k while avoiding the 10% early withdrawal penalty. Once funds are rolled to an IRA the early withdrawal penalty applies up to age 59 ½.
2. Roth conversion strategy
If you have after-tax dollars you would like to convert to a Roth IRA, rolling over your 401k to an IRA could cause complications. This is because the IRS requires you to consider the total amount of IRA assets, both pre-tax and post-tax when you convert funds from an IRA to a Roth IRA. This is called the pro-rate rule. You cannot segregate just the after-tax funds.
For example, say have $20,000 in after-tax IRA dollars and $80,000 in pre-tax IRA dollars and you would like to convert $20,000 to a Roth IRA. The pro-rata rule would require you to assume 80% of the conversion comes from pre-tax and 20% from after-tax. So, you would owe tax on $16,000.
401ks are not included in the pro-rata calculation.
By not having any pre-tax IRA dollars (because you kept everything in a 401k with a former employer) you may also be eligible for a backdoor Roth conversion.
The backdoor Roth conversion is a way for higher income taxpayers to fund a Roth IRA if their income is too high to qualify directly. Rather than making a direct Roth IRA contribution you would make your contribution to an after-tax IRA ($7,000 for 2025) and then convert those funds to a Roth IRA.
The pro-rata rule would likely make the backdoor Roth IRA strategy not worth it.
3. Legal protections
401ks and other qualified retirement plans are protected from creditors and lawsuits by the Employee Retirement Income Security Act (ERISA). IRAs generally derive their legal protections from the states and the level of this protection varies depending on where you are located.
4. Choice of investments in the plan
A big advantage of an IRA is that the universe of investments is available. Anything that is not specifically prohibited (life insurance, collectables, S-Corps) can be invested in your IRA if you can find it. The 401k will usually have a more limited, curated list of investment options. Some 401ks will also have a brokerage portal allowing you to invest in a broad range of securities.
What you want to determine though is are there investment options in your 401k that you would not be able to find outside of the plan? Also, there may be funds that are offered at a lower cost inside the 401k plan vs. if you purchased the same fund in your IRA.
5. Do you have company stock in the plan?
If you have accumulated employer stock in your retirement plan over the years it is possible to pay the lower capital gains tax rate on the growth (NUA) of the stock. It may still make sense to roll over the stock to an IRA and continue to receive tax deferral, however this is a calculation that should be done prior to making a rollover decision.
6. Stable value fund
A Stable Value Fund is an option in some 401k plans. They are pooled bond portfolios usually with an insurance component to protect against downside risk. In the past they have tended to have a slightly higher return than money market funds, especially during the period in the last decade when interest rates were near zero.
Stable Value Funds are large institutional funds and are generally not available to retail investors, meaning you may not be able to re-create this unique investment once you roll over your 401k to an IRA.
7. Cost of the plan
401k plan costs can vary widely. Generally, the larger the plan the lower the costs. In many cases you can find lower investment costs outside of the plan in an IRA. However, especially in large plans there may be access to lower cost versions of certain funds that would be unavailable to you in an IRA due to scale.
Think through each of these considerations before you roll over your 401k. For most people, after considering these factors it will make sense to roll over the plan. Having your funds consolidated in an IRA (instead of spread out at multiple old employer 401k plans) makes managing them simpler and opens up most of the universe of investment options. A good Advisor will consider these factors when making a recommendation.
Personally, I prefer to have my retirement funds in one IRA account and for me the benefits have outweighed the negatives. However, this is a decision that should be made on an individual basis and generic advice should not be relied upon.
If you have any questions about these factors feel free to contact me. I try to answer all reader emails.
