401k vs IRA

401k vs IRABy Stewart Lawson

When you transfer funds away from your previous employer you can easily roll that money into your current employer-sponsored plan, or you can place the funds into a self-directed IRA. There are advantages and drawbacks to both options, which are briefly outlined below.

Rolling over an old 401k plan into a new 401k account.

Pros
Besides the fact that there is likely a minimum account balance required to keep your old 401k parked with your previous employer, there is no minimum for transferring an old 401k to your new employer’s plan.
By moving your old 401k money into your new employer’s plan, you won’t be at risk of forgetting about the money you left behind. Plus, if you move funds from an inactive 401k into a new employer-sponsored plan, you could earn a higher interest rate if the new account’s balance reaches a certain threshold.

Many employers are willing to match a percentage of their employees’ 401k contributions, at least up to a certain point. To illustrate how this could benefit you, picture making annual contributions of $5,000 for 40 years with an average return rate of 7% per year. If your employer made a 50% matching contribution then you could end up with over $1.5 million.

Some employer plans offer institutional funds that have lower-than-average fees and decent payout averages, and individual investors are often unable to access these same funds via a self-directed retirement account.

Cons
Investment flexibility, or a lack thereof, is a major drawback of leaving your 401k with your previous employer or transferring it to a new employer’s plan. Employer-sponsored plans offer a very limited range of choices and alternative investments, such as real estate and precious metals, are almost never available to you.

While 401k fees could potentially be lower than those of an IRA, this is not always the case. It may take some leg-work to find the lowest-fee funds when dealing with self-directed IRAs but they are out there, and the administrative fees that employer-sponsored plans attach can slowly but surely seep your hard-earned savings.

Rolling your old 401k over to a Self-Directed IRA.

Pros
A 401k rollover into an IRA opens up a whole new world of investment options. In addition to the stocks, bonds, mutual funds and interest-bearing accounts you can choose to invest in real estate, a private company or even physical gold and silver.

Though we prefer not to dwell on such things it is imperative to think about what happens to our assets after we’re gone. Very few 401k plans allow your heirs to take distributions over a long period of time, meaning that the taxation of your 401k could be an immediate burden on your loved ones. With IRA plans your beneficiaries can small, taxable distributions over an extended period of time, thus allowing them to live comfortably without having to fret over a massive tax bill. IRAs also provide your heirs with the opportunity to continue to grow your savings in a tax-deferred manner.

Cons
401k plans allow owners to take loans from those accounts, and you have up to 5 years to repay the money, penalty-free. This is not an option with Individual Retirement Accounts.

Contribution limits for IRAs are much lower than those of 401k accounts. The IRS recently announced that the 2014 IRA annual contribution limit is $5,500, and you can contribute an extra $1000 per year if you are 50 or older. Standard 401k plans allow contributions of up to $17,500 per year, and that figure can go as high as $52,000 if you are self-employed. If you have a 401k and are 50 or older then you can tack on an additional $5,500 in “catch-up” contributions.

The Bottom Line.
There is rarely a blanket option that covers everyone regardless of their personal circumstances. By knowing the rules that govern 401k rollovers and IRA plans you can make the best decision for yourself that will benefit you now and your loved ones in the future.