Rolling Over a 401k: What You Need to Know

By Financial Advisor Carrie McDonnell

Should I rollover my old 401k?

This is an important question considering how many Americans have access to 401k plans now (69% of the private sector) and the frequency with which Americans change jobs, leaving non-active 401k’s in their wake.¹

To be sure, having access to a 401k is largely a good thing. 401k plans can help provide employees with the structure and incentive to make saving for retirement a priority, especially when a company offers a match. However, a 401k plan may not be the best place to leave your funds invested after you’ve left your job. Below are some elements an investor should take into consideration when deciding whether or not to rollover an old 401k into an Individual Retirement Account (IRA).²

What are the potential drawbacks to keeping funds in my old 401k?

1. 401k plans have limited investment options. A plan sponsor is legally required to offer a variety of investment options to their employees, but some 401k plans have as few as 5 options. Compared to the hundreds of investment options you could have access to in an IRA, 401k’s can be quite restrictive.
2. 401k plans can lack quality and diverse investment options. For many, the default investment is a target-date fund…in fact 56% of 401k participants opt to use a target-date fund as their primary investment.³ Target date funds range in quality and cost and many have lower historic returns than what you could expect from a diversified low fee index strategy.
3. 401k’s can have high administrative fees, most of which are passed along to the employees. These fees include the cost of the investment funds (aka expense ratios), third party administrator fees and 401k company management fees.

How could rolling my old 401k into an IRA impact the growth of my funds?

Take a look at the chart below. Say you leave your money in a 401k and, due to high expense ratios (cost of funds) and 401k management fees, you pay roughly 2% in fees. Compare that option to rolling your 401k into a Traditional IRA with low expense ratios and advising fees of 0.75%. Assuming the same investment performance, the trajectory of your account balance is significantly higher in the rollover scenario.

This hypothetical illustration doesn't represent any particular investment nor does it account for inflation. It assumes $50,000 is invested into an account that earns 7% a year for 50 years. The y-axis represents total portfolio value net of all fees, while the x-axis represents years assuming a 7% annual return, across three different annual fee rates. Calculations assume fees are paid on an annual basis in arrears based on a percent of the year-end portfolio value. The differences in account values across different fee levels represents both the amount paid in expenses as well as the "opportunity costs"—the amount you lose because the costs you paid are no longer invested. There may be other material differences between investment products that must be considered prior to investing. Investing involves risks. Performance cannot be guaranteed.

Will I be taxed or penalized if I roll over my old 401k?

When executed correctly, rollovers are non-taxable events. Always be sure to check with your 401k company first regarding any other potential penalties. If you left a job and are no longer a participant in that 401k plan, you most likely can rollover without penalty.

What are other benefits to rolling over my old 401k?

Rolling over old 401k’s and consolidating these accounts into an IRA can help simplify your life. Rather than logging into multiple institutions to view your investments, you can bring these accounts all under one roof. As Henry David Thoreau once wrote, “Our life is frittered away by detail. Simplify, simplify.”

1. https://www.bls.gov/opub/ted/2023/retirement-plans-for-workers-in-private-industry-and-state-and-local-government-in-2022.htm
2. The decision to rollover a workplace retirement plan into a personal IRA account should be considered on a case by case basis, as it may not always be the most prudent choice, depending on the specific facts and circumstances of the case.
3. https://www.ebri.org/content/target-date-funds-evidence-points-to-growing-popularity-and-appropriate-use-by-401(k)-plan-participants