If you're fortunate enough to have access to a 401(k) plan at work, then one of the biggest questions you'll face when you quit your job is what to do with it. In some cases, you'll have the option to leave your retirement money with your former employer, and that can sometimes be the best move. However, using a rollover IRA can also help you avoid the most fundamental mistake that most people make when they change jobs: taking their 401(k) money out and putting it in a regular bank account. Below, we'll look at three reasons why rollover IRAs can be your best option.
1. When you're forced out of your old 401(k)
Typically, it's up to you to decide what to do with your old 401(k) when you switch jobs. However, when the account balance is relatively small, employers have some choices that can essentially force you out of your old 401(k). Under current law, if you have between $1,000 and $5,000 in the account, then your employer is required to automatically roll over your 401(k) plan balance into an IRA that the employer chooses. If your 401(k) balance is less than $1,000, then your employer can simply cut you a check -- leaving it up to you to navigate the complex rules of rolling over the money without triggering taxes and potential penalties.
If you take steps to roll over your 401(k) balance to a rollover IRA, then you'll be the one to pick an IRA provider that's best suited to your needs. Specifically, by choosing financial institutions that won't charge high setup and maintenance fees, you'll preserve your retirement savings so they'll actually be there for you when you need them.
2. When your old 401(k) is bad
Even if you have a high enough 401(k) balance that your old employer doesn't force you out of its plan, you may still want to consider the benefits of a rollover IRA. Look at how much your old employer's 401(k) plan charges you in fees and compare that amount to what you'd have to pay to an IRA provider.
Good 401(k) plans can actually have lower fees than an individual IRA. If your employer has access to low-cost institutional share classes of mutual funds, then their expense ratios will often be less than what the same fund company charges for the regular shares it offers ordinary investors in IRAs. In that case, it'll pay to leave the money in the old 401(k). However, bad 401(k) plans only give you access to expensive, low-quality investment options. If that's true for you, then a rollover IRA can let you pick lower-cost investments that will preserve more of your money for the long run.
3. When you want to make special investments
Finally, IRAs are much more flexible than 401(k) plans when it comes to the investments you can choose. Most employers structure their 401(k) plans to give you access only to a select number of mutual funds. That might be OK if you're comfortable investing in stocks, bonds, and other assets that are typically offered through popular mutual funds.
However, IRAs give you a much wider universe of available investments. Even when you use traditional financial providers for your IRA, you can choose from individual stocks and bonds in addition to funds, and you can also select exchange-traded funds that give you more ability to customize your exposure and take advantage of brief opportunities to pick up shares cheaply. Also, self-directed IRAs are available for those who are interested in more exotic investments, such as specific tracts of real estate, equity interests in small businesses, or even private placement investments. These special IRAs come with added risk, but for those who can tolerate that risk, a rollover can provide funding for lucrative investments.
Look at rollovers
If you have money in a former employer's 401(k) plan, take a look and see if a rollover IRA might be a better choice for you. For those who want more control over their retirement, rollover IRAs often offer advantages that outweigh any disadvantages from moving money out of their old 401(k).