Can I Transfer My 401(k) Funds into an IRA?

As an accountant and financial planner, I am often asked by clients for advice on what to do with their retirement funds if they change jobs or become self-employed. There are a few options, each with its own set of pros and cons.

When you leave an employer for another or for other opportunities, you can do one of two things with your built-up 401(k) plan funds. You can leave it parked where it is (and the employer must let you do so if you have more than $5,000 vested. Alternatively, you can roll it into an Individual Retirement Plan (IRA) that you control.

There are several considerations to ponder when deciding which road to take. Leaving your money in the 401(k) plan may seem like the easiest option (the path of least resistance) but keep in mind that you will have to communicate with your former employer every time you have an administration issue with your plan. If you did not leave your employer on the best of terms, this can be stressful. Also, 401(k) plans often have very limited investment options and therefore, if you move your funds into an IRA, you may have more investment options and have access to a wider array of mutual funds or stock or bond options.

You have two basic choices when deciding to roll your 401(k) plan into an IRA. You can choose to roll it into a traditional IRA or a Roth IRA. The tax consequences of each are quite different. When you fund a 401(k) plan, you do so with after-tax dollars. This means that you get a tax deduction for your contributions. Also, the investment return in the plan grows on a tax-deferred basis- you don't pay tax until you withdraw the money in retirement. A traditional IRA is also a tax-deferred product and any 401(k) funds transferred into it will have no tax consequences until withdrawal. It will look much like your existing plan but may have more investment options and you will have more control over the mix of investments in the plan.

A Roth IRA, on the other hand, does not allow a tax deduction for contributions. When contributions are withdrawn on retirement, they are also not taxed. The investment income that builds in the plan can be withdrawn tax-free. In order to transfer 401(k) funds into a Roth IRA, you must pay tax on the entire rollover amount. This can bite into your savings.

Depending on the plan you choose, you may be able to roll your funds over into a new employer's 401(k) plan eventually but there are few reasons to do so when an individual account offers you more flexibility.

Regardless of the plan you choose, review it carefully to ensure that you understand all plan fees and options. That way, you can maximize your retirement funds and have more control over your investments.