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What You Need to Know Before Rolling Over Your 401K

scale representing weighing the pros and cons of rolling over your 401k

With the staggering job losses in 2020, many people are asking what they should do with the 401K they have with their former employer. Brokerage firms will tell you that rolling over your 401K into an IRA is the best option, but what they don’t tell you is that they make A LOT of money from these rollovers. So should you take their advice? Here is everything you need to know before you decide to roll over your 401K.


The absolute worst thing you can do is withdraw your money from your 401K. In the finance world, this is sometimes referred to as an indirect rollover, so watch out for those. The reason it is so important to do a direct rollover and to avoid withdrawing your money is that if you do, you’ll pay income taxes on it and unless you’re 59 ½ or older, you’ll also pay a 10% penalty. That’ll leave you with significantly less money. So, whatever you do, make sure to do a direct rollover and DO NOT WITHDRAW YOUR 401K MONEY!

Your Rollover Options

You have two options as to how you can roll your money over. If you have a new job (first of all, congrats!) and that job offers you a 401K, you can roll your old 401K into your new plan. Not all plans allow transfers, so first, you’ll need to check that your new one allows this. If it does, you’ll also want to check that it offers low fee investing options before transferring your balance. The average 401K investment fund fee is .45%, so if your plan only offers investment options with higher fees than that, you may want to consider option two instead.

Your second option is to roll your 401K into a traditional IRA. Since an IRA is a completely different type of retirement account, you’ll need to take some more things into consideration before switching. To help you decide whether you should switch or not, here are the pros and cons of rolling your 401K into an IRA.

Pros of Rolling Into an IRA

More Investment Options

One of the main arguments you’ll hear for rolling your old 401K into an IRA is that you’ll have more investment options. While this is true, this is also where many people get themselves into trouble. Remember when I said that brokerage firms make a lot of money by getting you to switch to an IRA? Well, offering you access to more or “better” fund options is usually how they do it.

While you will have access to more investment options with an IRA, many of these options will charge much higher fees than your 401K options do. That’s because a lot of the new funds you’ll be able to choose from will be actively managed mutual funds that are notorious for charging exorbitant fees without providing the excessive returns they promise.

If you decide to switch to an IRA to take advantage of having more investment options, make sure you aren’t swindled into investing in high fee funds that will benefit the brokerage and could end up costing you thousands.

No Terminated Participant Fees

Some companies charge former employees a fee for leaving their money invested in their 401K plan with their previous employer. These are sometimes called terminated participant fees. Check your prior employer’s plan info to see if you’ll be charged this fee. If you will be, switching to an IRA will allow you to avoid paying it.

Access to Cheaper Funds 

While many people get misled into investing in high fee mutual funds when they change over to an IRA, you also have the potential to save money on fees if you switch. Depending on which brokerage provides your 401K, you may have access to super low-cost index funds, ETFs, and even target-date funds with your new brokerage. Make sure to evaluate the full fee structure for your old and new plans before you make the switch.

Maintain Full Bankruptcy Protection

One benefit 401Ks have over IRAs is that they are fully protected from creditors if you file for bankruptcy. However, rolling over your 401K into a traditional IRA allows you to retain this protection. The key is that you need to be able to show that the original source of funds was from a 401K. To reduce confusion on the source of funds, make sure to open a separate rollover IRA if you have already been contributing to another traditional IRA.

Cons of Rolling Into an IRA

No Loans or Early Withdrawals 

You should exhaust pretty much all other available options before taking out a loan from your 401K, but you do have the option to do so if you get into really dire financial straits. If you switch to an IRA, this loan option will no longer be available to you.

The minimum age for early withdrawals is also higher for IRAs at 59 ½ than with a 401K where you can begin to withdraw the money at 55, penalty-free.

Huge Tax Bill for Company Stock

Many people who work for large companies receive some of their compensation in the form of stock options. If this is you, it may be a better idea to transfer your company stock into a taxable account and pay income taxes now, so you only have to pay capital gains tax (which is typically much lower) on any future earnings. The rest of your 401K can then be rolled into a deferred tax account like a traditional IRA. If instead all of your stock is rolled out into a traditional IRA, you’ll have to pay income tax on all future earnings, which could land you with a much higher tax bill. Make sure to check with a tax professional to find the best option for you before deciding to switch.  

Required Minimum Distributions 

If you’re a workaholic and planning on working forever, you may want to consider when you will be required to start taking distributions. 401Ks never require you to start withdrawing your money, while IRAs require that you start taking the minimum distribution at 70 ½.

Weighing all of the tax, fee, and distribution options before rolling over your 401K can save you money and heartache in the future. Don’t fall prey to the brokerage firm’s promises about the benefits of switching to an IRA. They’re trying to make money off of you, not help you live your dream retirement. Make sure you do your own research on all of the hidden fees and taxes you could end up paying by blindly rolling your money into an IRA. As the saying goes, the grass isn’t always greener on the other side.

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