As the summer begins, many savers across the country may have some extra time to think about optimizing their retirement planning strategy. While rolling over your old 401(k) to an IRA can have some serious benefits, there are several situations in which you might want to think twice about making that move.
Below are three reasons you might want to keep your old 401(k) plan exactly where it is.
1. You're satisfied with your former employer's 401(k) plan
Not all 401(k) plans are prohibitively expensive. Many low-cost plans exist that offer more-than-acceptable investment structures. For most people, this means access to passively managed index mutual funds, which tend to be more than enough for most small investors.
The upside is that most of these funds -- like the ones that track the S&P 500 -- don't require much ongoing management. If you're satisfied with your former employer's 401(k) plan and its underlying investment options, there isn't any emergency to move it.
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2. You want to do backdoor Roth contributions
Contributing to a Roth IRA generally makes lots of sense. The problem is that Roth IRAs also come with income limitations, so you'll only be able to contribute the annual maximum if you make less than a certain amount in any given year. (In 2023, that's $138,000 if you're single and $218,000 if you're married filing jointly.) The way around these limitations is to opt for a backdoor Roth IRA contribution, instead.
But be careful. If you have pre-tax money in other traditional IRAs (like ones resulting from previous 401(k) rollovers), you may be subject to the pro-rata rule. This states that money converted from traditional IRAs to Roth IRAs is taxable on a pro-rata basis. In other words, you might be subject to income tax on a portion of your backdoor Roth contribution if you already have pre-tax money sitting in traditional IRAs.
The good news is that, if you keep your pre-tax money in your 401(k) -- i.e., you choose not to roll it over to an IRA -- you can avoid the pro-rata issue entirely. By keeping the money within the 401(k) structure, you then pave the way for potentially tax-free backdoor Roth conversions. Needless to say, this can get complex quickly, so consult a qualified financial advisor if you're not sure how this works in practice.
3. You don't want any administrative hassle
Rolling over your 401(k) is generally an easy process -- but not always. Direct 401(k) rollovers occur when you move your retirement plan from one financial institution to another (like when you move a 401(k) to a traditional IRA at an outside provider) and can be simple to set in motion.
You'd start by calling your old 401(k) plan administrator and requesting a direct rollover to a financial institution of your choice. Within a relatively short time frame, you'd see the money appear in your new account.
Indirect rollovers aren't so seamless. With indirect rollovers, you receive your retirement funds personally, minus any tax withholding -- usually 20% of the total account balance. Then it's your responsibility to redeposit the gross amount of your retirement plan account balance within 60 days.
If you miss the deadline, your rollover will likely be deemed an early withdrawal, and you could be on the hook for both ordinary income tax and an early withdrawal penalty if you're younger than 59 1/2. Ouch!
Keeping your retirement funds in your old 401(k) eliminates the potential for these costly errors.
Keep things simple when you can
A 401(k) rollover makes perfect sense in a variety of scenarios. What ultimately matters is that you take the time to decide whether it's a smart move for you. If you think you'll be in greater control of your retirement money if it's in a new account, then it might make sense to move your 401(k).
But there are many instances when it's better to leave well enough alone. If you're satisfied with your old 401(k) plan's investment options, have no need for a backdoor Roth IRA, or don't want any administrative hassle, skipping a 401(k) rollover can make a lot of sense. No matter what you choose, though, be sure to give it some thought before making any moves.
