What Are The Disadvantages Of Rolling Over A 401k To An IRA?

Last Updated on February 15, 2024 by Ben

There are a lot of disadvantages to rolling over your 401(k) to an IRA. Depending on your account size, you can be subject to taxes or penalties on the amount transferred. Additionally, you won’t have access to employer-funded programs or advantages like matched contributions and financial guidance. Your potential for growth and investing opportunities may be restricted as a result. Before choosing whether it is worthwhile to roll over funds from a 401(k) to an IRA, weighing all the advantages and disadvantages is vital.

Avoid making these expensive blunders when transferring a 401(k) to an IRA. 


  • Make sure you are familiar with the numerous rules that apply to 401(k) plans and individual retirement accounts before transferring your money (IRAs).
  • If the rollover procedure is not carried out properly, it may be considered a distribution subject to taxation and a potential early withdrawal penalty.
  • Additionally, in some situations, the rollover procedure should be cautiously started.

Take the necessary measures to transfer assets from your workplace savings plan to an individual retirement account. An unwise decision could result in costly errors and unavoidable repercussions.

Although 401(k) plans and IRAs offer similar advantages for retirement savings, their requirements are different. You must be aware of these potential dangers since they can present significant roadblocks to completing a rollover.

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The Roll Over Technique

It’s crucial to avoid getting a check made out to you when you’re converting your retirement assets to an IRA. For your benefit, the assessment should be made payable to the IRA custodian, such as Schwab, Fidelity Investments, or another investment manager. No tax will be deducted in this manner.

However, if the check is made payable to you, it will be regarded as a distribution, necessitating the withholding of 20% of your 401(k) balance for tax purposes. For instance, if your 401(k) balance is $50,000 and the rollover check is made out to you, 20% of the money will be withheld by law as an obligatory tax, leaving you with only $40,000.

If this occurs, putting the check into your rollover IRA will only be possible if you have the extra $10,000 on hand. Otherwise, if you are under 5912, the amount withheld is considered a taxable distribution and may be subject to an early withdrawal penalty.

If you Own Stock in a Company

Rolling the assets over to an IRA can have risks if you’re a retirement saver and have company shares and other investments in your 401(k). Transferring such claims to a brokerage account rather than placing them in an IRA with the rest of your assets is prudent if they have unrealized gains. Following the transfer, you would be taxed based on the cost basis, which is the value when you first purchased the assets in your 401(k).

However, any 401(k) growth would be subject to long-term capital gains rates (0%, 15%, or 20%, depending on your income) when you sell the stocks from the brokerage account. In the long run, this might result in paying less tax than if the store had been transferred to an IRA and later withdrawn.

For instance, if you owned $10,000 worth of business stock with $20,000 in profits while holding it in your 401(k), you would only have to pay taxes on the $10,000 cost basis after transferring it to a brokerage account. Once sold, the $20,000 gain would be subject to long-term tax. Additionally, depending on how long it was held before being sold, any additional growth from the time it was transferred to the time it was sold would be subject to either short- or long-term gains tax.

The 55-Point Rule

You can take penalty-free distributions from your 401(k) if you’re over 55 and need to access your retirement assets (k). The opportunity to access the funds early is lost if you transfer the money to an IRA before reaching the age of 59 and 12. According to Brennan, someone might lose their job and wish to roll over their 401(k) to an IRA, but they need to remember how long they’ll be out of work. If this has already happened, there will be a 10% fee to access these funds unless there is an extenuating circumstance.

If someone wishes to transfer money to an IRA while still within the age range of 55 to 5912, a partial rollover may be the best option. It could be because the charges are cheaper or there are more investment alternatives. As a result, they can keep some of their funds in their 401(k), providing themselves access when needed before reaching the age requirement for withdrawals without penalty.

Spouses Should Be Aware Of

Spouses should be aware that they may forfeit their entitlement to receive a 401(k) amount as the sole beneficiary if they roll it over to an IRA. Unless they sign a waiver, the spouse is the mandatory beneficiary under the workplace plan. But once the money is in an IRA, the account owner can choose any beneficiary without the beneficiary’s permission.

Making a withdrawal from your 401(k) to send to your ex-spouse by the terms of your divorce decree may be a mistake to avoid as you may be subject to taxation and penalties if you are under 5912 years old. Assets allocated to an ex-spouse must go via a qualified domestic relations order (QDRO) and have judicial approval to assure penalty-free distributions.

The Drawbacks of Converting your 401(k) to an IRA

Although stable value funds are a fantastic choice for 401(k) investors, IRA rollover account holders may only sometimes have access to them. Although money market funds are an alternative for investment, they often offer far lower interest rates than guaranteed or stable value fund options.

-This lack of consistent value or guaranteed fund investment options may be detrimental to those getting close to retirement as they work to increase their savings.

-IRA account holders should examine if their advisor is a fiduciary and expected to consider the client’s best interests when researching investment possibilities. It is only sometimes the case, and any recommended investments might work out better for the advisor than the investor. However, employers and investment advisors connected to 401(k) plans must be fiduciaries.

-In a recent analysis by the Center for Retirement Research, average returns in an IRA over 12 years were found to be 2.2%, compared to 3.1% in 401(k) plans, demonstrating the performance gap between IRAs and 401(k)s. What a remarkable 41% gain! The primary reason for this variance is the higher fees paid by IRA rollover participants.

-Financial institution rules governing IRA rollovers were an effort by the Obama administration to solve this problem; however, these reforms have subsequently been overturned. Despite this setback, IRA participants must comprehend their rights and take action to guarantee superior investment returns.

-In 2017, the typical American worker had a 401(k) balance of just over $100,000. Unfortunately, only a few advisers can handle accounts of this scale. As a result, participants will either employ discount brokerage firms without objective investment advice or pay excessively high fees to huge advising firms.

-It might be challenging to find unbiased investment advice for consumers considering rolling over their 401(k) holdings. While mutual fund providers frequently favor suggesting their funds over others that may be superior options, brokerage firms have financial incentives to promote assets that benefit them financially.

-When advisers accept smaller accounts, they frequently impose steep fees of up to 2% annually. However, many 401(k) plan participants can get cost-free, impartial investing advice from the advisor of their plan.

-Due to the high minimums associated with the cheapest mutual fund share classes accessible outside of retirement plans, those who roll over their 401(k) balance into an IRA also face considerable difficulties. These account holders are always required to invest in more expensive retail share classes, which are more costly overall and may also be subject to transaction fees. In contrast, members in 401(k) plans have free access to low-cost options and can buy, sell, and transfer money without paying fees.

-Other disadvantages include potential early withdrawal penalties when retiring before age 5912 if the possessions are retained in an IRA rather than a 401(k) and decreased legal protection from creditors and lawsuits for IRA account holders (k).

-You might not be able to borrow money from your IRA, but you might be able to borrow from your 401(k) (k). Even though I’m not a fan of these loans, it’s something to think about if banks aren’t offering any.

-There are many benefits to transferring your 401(k) or IRA into your current employer’s plan. Your retirement accounts will be combined into a single, easier-to-manage account. Additionally, more thorough investing advice will be given to you.

-Unfortunately, the data needed to decide on a rollover must be presented in a way that is easy for everyone to understand. People have a financial incentive to have clients roll over their assets and frequently end up providing them with little advice. Because of this, bad decisions regarding whether to turn over or not are regularly made.


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