Why You May Want to Consider an IRA Rollover

If you recently landed a new job, you may have questions about what to do with the funds in the 401(k) or 403(b) retirement plan with your former employer. The good news is that by law, you must be given at least 30 days to decide what to do with your 401(k) when you switch jobs. Plus, you have several options, which include:

1. Rolling over your employer-sponsored plan into an IRA;
2. Leaving the money in your former employer’s plan;
3. Rolling over the money to your new employer’s plan (if the plan accepts transfers);
4. Taking the cash value of your account.

Choosing option 4, cashing out your account, may seem simple—but it’s a costly option. If you ask your plan administrator for a check, your employer will withhold 20 percent of your account balance to prepay the tax you’ll owe. In addition, the IRS will consider your payout an early distribution, meaning you could owe the 10 percent early withdrawal penalty on top of combined federal, state and local taxes.

But if you’re considering the first option, an IRA rollover, how can you decide if that’s the best option for you? Here’s what you need to know.

What is an IRA rollover?

An IRA rollover is essentially the transfer of funds from one retirement account into a traditional IRA. You effectively move the funds from your old plan, while still maintaining the tax-deferred status on your retirement assets. The resulting account is also sometimes known as a Rollover IRA.

A key reason people do IRA rollovers is when they changes jobs. The term “IRA rollover” also applies if you have multiple IRAs (or other similar retirement accounts) that you want to combine into a single account.

While IRAs have relatively low contribution limits compared to some other retirement plans ($6,000 per year as of 2022, or $7,000 per year for savers age 50 or older), there is no limit to how much you can roll over into an IRA from other qualified accounts.

Why You May Want to Consider an IRA Rollover

You want to keep contributing

When you leave your current employer, most employers will allow you to leave your 401(k) or 403(b) where it is. But, if you choose this route, you won’t be able to continue making contributions to the account. By rolling your account over into an IRA, you’ll be able to continue to add additional funds—up to $6,000 per year as of 2022, or $7,000 per year if you’re 50 or older.

You want all of your funds in one place

Depending on how many times you change jobs throughout your life, it’s possible that you could end up with several different retirement accounts. That can make it more difficult for you to keep tabs on all of your retirement savings plans as well as their accompanying fees. Consolidating your retirement accounts into an IRA rollover account could be a simpler solution.

You want more investment options

One drawback to using a 401(k) plan to save for your retirement is that you’re limited as to what investments you can select. Typically, you’ll only be allowed to select mutual funds or target date funds that are a part of your plan, which could rule out investments that you may be interested in. IRAs offer much more freedom in selecting investments. On the other hand, some employers may give you access to funds that aren’t available to the general public. If you’d like to leave your money in such a fund (and it’s allowed), you may consider leaving your money with your former employer.

You can’t (or don’t want to) leave your retirement account behind

While many employers will allow you to leave your 401(k) behind, some employers don’t. But even if you have this option, you may not want to leave it behind.

One cause for concern is that your former employer might go out of business or merge with another company. While your money would likely still be safe, the plans could change or move around, making it harder for you to keep track of where your funds are.

You want to convert it into a Roth account

One of the most common reasons that people consider an IRA rollover is because it offers the opportunity of turning a traditional retirement account into a Roth IRA account.

With a Roth IRA account, you pay taxes up front on your contributions, and then your withdrawals (both principal and earnings) are tax-free in retirement. You also won’t face required minimum distributions in the same way that you would with a traditional account. You can also withdraw the funds you have added from a Roth IRA before you are 59½ without incurring taxes—but if you withdraw any of its earnings, you’ll incur a 10 percent penalty.

If you roll over traditional IRA funds into a Roth, you’ll need to pay income taxes on those funds in the year that you do the rollover.

Keep in mind that each choice offers advantages and disadvantages, depending on desired investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment and your unique financial needs and retirement plans. To determine the best strategy while minimizing your tax burden as much as possible, you may find it helpful to work with a financial professional or tax advisor.