Self Directed IRA vs 401k : The Puzzle of the 401k Rollover

July 22, 2024
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We’ve all been there. You’ve finally decided to leave the job that’s been driving you crazy. Maybe you found something better? Maybe you’re retiring? Your boxes are packed and you’re headed out of the office for the last time. Everything is great, but then you remember that you need to make a decision about your 401k and suddenly it starts raining on your parade.

If you’re leaving your job there are really only four courses of action available to you when it comes to your 401k. You can leave your money in the previous employer’s plan, roll the funds into a new employer’s plan, roll your money into an IRA, or cash out entirely.

So which do you choose?

Option 1: Rollover into a New 401k

If you’ve moved to another company you probably have the option to roll your old 401k into a new one.

There are many benefits to doing this. By consolidating your old 401k into a new 401k, your financial situation will be made simpler. You’ll retain all the benefits of the 401k environment, such as the all important employer match and earlier withdrawal date. Plus you’ll enjoy the simplicity of consolidating all your retirement funds into one place.

Consolidation means you’ll only get one statement in the mail each month. This can help you keep a clear working understanding of your financial big picture.

Option 2: Keep the Money Where it Is

As good as consolidating into one 401k at your new company sounds, though, there are some problems with that option.

Most of these problems boil down to one thing; the process of rolling one 401k into another is far from simple and it’s possible you might lose money trying to do it. A 2013 report from the Government Accountability Office, the government agency in charge of providing auditing and investigative services to congress, addresses the many hurdles people have to clear when attempting a 401k to 401k rollover.

The GAO report points out, for example, that sometimes the new 401k will have a rollover waiting period before you are allowed to move funds into the account. It also points out that the new 401k will often have a long verification process which requires you to make sure that your previous employer sends the new plan lengthy documentation to prove the tax status of all the money in your account. Lastly, the report points out that it’s not necessarily in the best interest of the old 401k to release the funds to the new 401k even after you’ve made the request so sometimes they take a while to do.

In short, moving money from one 401k plan to another can be a hassle many people just don’t have time for. Unwilling to deal with this, they just leave the money in the old 401k which means, of course, that they avoid the headache but lose all the benefits of consolidation.

Option 3: Rollover in an IRA

The third option is to consolidate all of your money into an IRA. Often people switching jobs or beginning retirement face considerable advertising pressure to choose this option. Big firms are constantly advocating for people to do this and indeed most retirees choose this option.

When you move money out of a 401k and into an IRA, things do change. You will no longer be getting any kind of employer matching, for one thing, as well as your ability to access the funds penalty free at age 55 if you have retired quit, or have been fired. IRA participants have to wait until they are 59 ½ to withdraw funds penalty free.

When you move from a 401k to an IRA, your fees will also be different and you’ll need to make sure you understand exactly what you were paying for the old 401k account and what you’re paying for the new IRA.

On a side note, many people decide to keep their money in old 401k instead of rolling it over to an IRA, because they think they’ll lose the loan option on their 401k if they do that. Most 401ks do allow you to take loans from them and IRAs do not. Understandably, people don’t want to lose this option. The truth, however, is that if you are no longer working for the employer that offered the 401km you no longer have the loan option anyways.

Benefits of Rolling Your 401k into an IRA

There are definitely benefits to consolidating your retirement money into an IRA, especially if you are leaving the employer where the 401k was held.

The biggest advantage is that you’ll probably have way more investment choices. In most 401ks there’s a short list of options, usually target retirement date funds, for how you can invest your money. In an IRA you can invest in funds, individual stocks, annuity options, real estate investment trusts, guaranteed income options, and a myriad of others. IRAs open you up to the full scope of investment choices, meaning you tailor your strategy more to your specific needs and goals.

Aside from that, opening an IRA usually comes with an advisor who can give you more advice and help with paperwork than you received when your money was held in a 401k.

Option 4: Take the Money and Run

The fourth option is the black sheep of this list and for good reason.

Simply withdrawing the cash from your 401k account when you leave a job is certainly tempting. It can be especially alluring to people who, for whatever reason, are leaving their job in the midst of a stressful situation. Maybe your new position doesn’t pay as much. Or perhaps you need to retire earlier than you thought.

Whatever your reason for considering a cash out of your 401k, you might want to take a breath and really think this through. If you’re under the minimum age for taking distributions from your 401k, you will pay a pretty big fee for taking the money out. There’s also a mandatory 20% federal withholding on all withdrawals even if they are rolled over. The only way to avoid this is by doing a direct rollover aka a direct transfer which is tax free.

You’ll also owe income tax on all that money you withdraw which, depending on the balance of your account, can be a surprisingly large tax bill to swallow all at once. In the end, you also lose all the money you would have made by keeping that money invested over the years.

Basically when it comes to the self directed IRA vs 401k decision, a cash out should be your last resort

Self Directed IRA vs 401k : What’s Best For You?

Whatever you choose to do with your 401k when you leave a job, make sure that you’ve researched your options thoroughly. This is one case where you really don’t want to do a slapdash job.

After all, this is your retirement on the line.

If you haven’t been in touch with your financial planner or advisor about this decision it might be a good time to contact that person. Or, if you don’t have a financial planner or advisor, you might consider finding one in your area who can help you work through your situation.

David Wilson is a Certified Financial Planner and Accredited Investment Fiduciary Analystat Vector Financial Solutions and the author of this blog. He has spent the last 30 years helping people in the greater San Diego area accomplish their financial goals and envision their best financial future. Call 760-741-3159 or email to get touch.

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