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Navigating job changes often brings the challenge of deciding what to do with your existing 401(k) plan. Depending on your current employer’s policies, you might have the option to keep your 401(k) where it is, transfer it to your new employer’s plan, or roll it over into an individual retirement account (IRA).
Choosing the right retirement plan is not a one-size-fits-all decision; it’s crucial to consider your personal investment priorities. If you’re contemplating a rollover from a 401(k) to an IRA, here are several advantages and disadvantages to ponder.
Advantage: Broader Investment Choices with IRAs
Many 401(k) plans primarily feature a variety of stock funds but limit your access to bond options. This strategy aligns well with accumulating wealth for retirement. However, as you near retirement, you may seek a plan that offers a more balanced investment approach, including bonds.
Advantage: Increased Control Over Investments
An IRA typically provides you with more control over your investment portfolio. You can curate your asset mix based on your personal preferences, choosing from a wider array of choices, including stocks, bonds, exchange-traded funds (ETFs), and more. While employer-sponsored 401(k) plans also give you some choice, the range tends to be more limited.
Advantage: Lower Fees associated with IRAs
Participating in an employer-sponsored 401(k) often means dealing with various fees that are out of your control. These costs can include administrative and management fees associated with the company plan.
With an IRA, you have the flexibility to choose where to open your account and which company manages it. This allows you to compare different providers and select the one that offers the lowest fees, helping to protect your investment returns. While there’s a possibility that you might pay higher fees for certain IRA options, you also have the ability to make informed decisions regarding those costs, unlike in a 401(k) plan.
Disadvantage: Reduced Creditor Protections
In general, 401(k) plans offer stronger protections from creditors, which are governed by the Employee Retirement Income Security Act (ERISA). This framework helps safeguard your retirement savings. In contrast, while IRAs may have some protections during bankruptcy proceedings, state laws vary significantly regarding protections from different types of creditor claims. In some states, IRAs may be partially exposed to creditors.
Disadvantage: Potential Loss of Net Unrealized Appreciation (NUA)
If your 401(k) includes shares of employer stock, you may benefit from a tax strategy known as net unrealized appreciation (NUA) that applies only to 401(k) distributions. For instance, if the stock of your company has appreciated significantly, opting for a lump-sum distribution allows you to pay ordinary income tax solely on the original cost of the stock rather than its total market value at the time of distribution. The remaining appreciation is subject to more favorable long-term capital gains tax rates when sold. This tax benefit is not available for shares held within an IRA.
Ultimately, the choice between rolling over a 401(k) to an IRA or keeping it as is depends on your unique situation. For individuals concerned about creditor protections or exploring NUA advantages, rolling over may not be the best option. Conversely, if you prefer to have more control over your retirement assets and enjoy a greater selection of investments, an IRA could be a favorable choice.
Source
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