When you leave a company, your 401(k) doesn't necessarily automatically follow you, but many Americans seem to think it does. As a result, 29.2 million 401(k) accounts have been left behind, according to estimates from a research company called Capitalize. These "forgotten 401(k)s" hold approximately $1.65 trillion in assets. 

Your money may be among those forgotten assets. If you hold a forgotten 401(k), it's time to consider what you might want to do with it.

In this article, we take a look at 401(k)s and IRAs, why you may want to initiate a rollover, and how to move forward with your forgotten investments.

Understanding the 401(k) and the IRA

According to the Investment Company Institute, Americans have invested $6.8 trillion in 401(k)s and $12.5 trillion in IRAs as of March 2023. If you've started investing for the future, some of your money is probably included in this total. But if you've ever wondered what exactly is the difference between a 401(k) and an IRA, you're not alone. 

Take a look at these brief definitions:

The 401(k)

A 401(k) is a retirement savings account typically offered by employers. It allows employees to contribute a portion of their pre-tax income into a diversified portfolio of investments. One of the significant advantages of a 401(k) is that contributions are tax-deferred.  You won't pay taxes on the money until you withdraw it in retirement.

The Individual Retirement Account (IRA)

An Individual Retirement Account (IRA) is a personal savings account that offers tax advantages for retirement savings. Unlike a 401(k), which is provided through an employer, an IRA is open to qualifying investors regardless of their current employment status. You can contribute to an IRA even if you already have a 401(k), and it allows for a wider range of investment options. However, you may not be able to contribute if you have too much income. 

The Rollover

A rollover happens when you move funds from one retirement plan or account to another. You might rollover investments from a forgotten 401(k) to your new employer's plan, or you could move them out of a 401(k) altogether and into an IRA. Each choice comes with its own set of pros and cons. 

The Benefits of Rolling Over Your Forgotten 401(k) to an IRA

Rolling over your 401(k) to an IRA can bring a plethora of benefits that can set you on the path to a secure and fulfilling retirement. 

First, an IRA gives you more control over your investments. With a 401(k), you are usually limited to the investment options provided by your employer. However, an IRA opens up a world of possibilities, allowing you to choose from a wider range of investment opportunities tailored to your specific goals and risk tolerance.

IRAs also typically offer lower fees. A report from the Government Accountability Office found that fees associated with 401(k) plans can significantly impact retirement savings over time, making IRA rollovers an attractive option for minimizing fees. IRAs, however, may also bring new fees such as those you pay an investment advisor.  

Furthermore, rolling over your 401(k) to an IRA allows you to consolidate your retirement savings into one account. This simplifies the management of your investments, making it easier to track your progress and adjust your strategy as needed.

Lastly, let's not forget about the tax advantages. While contributions to a 401(k) are tax-deferred, a rollover to an IRA may offer more flexibility in terms of when and how you can withdraw funds without being penalized. 

When You Shouldn't RollOver

Is there any reason you shouldn't rollover your forgotten 401(k) into an IRA?

Consulting with your financial advisor can help you make an informed decision aligned with your unique circumstances and retirement goals. When talking with your advisor, you may want to ask questions such as these:

• If I rollover my 401(k) into an IRA will I lose creditor protection? Some 401(k)s offer creditor protection, meaning they are shielded from certain legal claims. There’s some debate on this issue, but by rolling over into an IRA, you could potentially lose this protection, putting your retirement savings at risk in case of financial difficulties or legal issues. Historically, however, the courts have ruled to extend the same creditor protection found in 401(k)s to IRAs.

• What should I do if I plan to retire between 55 and 59½? Early withdrawals from a 401(k) can be subject to a penalty. However, 401(k)s offer a "Rule of 55" provision that allows certain penalty-free withdrawals starting at age 55 if you retire or separate from your job. This option isn't available with an IRA, which means if you plan to retire between 55 and 59½, keeping your funds in a 401(k) could provide more flexibility.

• What should I do if I plan to retire after the age of 72? If you plan to keep working beyond age 72, you might want to take advantage of a 401(k)'s more lenient required minimum distributions (RMDs) rules than IRAs. While RMDs are mandatory withdrawals that start after a certain age, 401(k)s may offer more favorable terms if you plan to continue working in your later years, allowing you to delay RMDs until you retire.

Different Types of IRAs to Consider When Rolling Over Your 401(k)

When considering a rollover, make sure to look at the different types of IRAs available. 

• The Traditional IRA. The most popular type of rollover is to a Traditional IRA. That’s because it operates very similarly to most 401(k) plan. With a Traditional IRA, contributions are made with pre-tax dollars, meaning you can deduct them from your taxable income. This can result in immediate tax savings and potentially allow you to invest more dollars towards retirement. The funds in a Traditional IRA grow tax-deferred, and you will only pay taxes when you withdraw the money in retirement.

• The Roth IRA. Roth IRA contributions are made with after-tax dollars. This means you don't get a tax deduction for your contributions, but your withdrawals in retirement are tax-free. Additionally, Roth IRAs offer the advantage of tax-free growth.

• The Self-Directed IRA. With a Self-Directed IRA, you have the freedom to invest in a wide range of assets, including physical real estate, precious metals, private equity, and more. This may allow you to further diversify your portfolio.

• The SEP IRA (Simplified Employee Pension IRA) or a SIMPLE IRA (Savings Incentive Match Plan for Employees IRA). These types of IRAs are specifically designed for self-employed individuals and small business owners. They offer higher contribution limits and are relatively easy to set up and maintain.

What to Consider Before Making the Move

Before rolling over your forgotten 401(k) to an IRA, ask a few key questions:

• Does your old employer’s 401(k) plan have any unique benefits or features that you would give up by rolling over to an IRA? 

• Would you pay more in fees associated with your IRA provider than you do with your 401(k)? 

• Does the current 401(k) plan offer a diverse range of investment options that align with your risk tolerance and financial goals? 

• Would I prefer to do a rollover to my new or existing employer’s 401(k) plan?

Additionally, consider any potential tax implications of a rollover. This will depend on the type of IRA you choose. A financial advisor or tax professional can help you understand the tax consequences of rolling over your 401(k) to an IRA. 

How to Rollover Your 401(k) to an IRA

Once you've made the decision to rollover your 401(k) to an IRA, the next step is to understand the process and take action. 

1. Research your options. Start by researching different IRA providers (such as Vanguard, Schwab, Fidelity, your bank branch). Consider factors such as fees, investment options, customer service, and reputation before making your selection.

2. Choose an IRA provider. Once you understand your options, select a provider that aligns with your goals, values, and preferences. Look for one that offers low fees, a wide range of investment options, and excellent customer support.

3. Contact your 401(k) provider. Reach out to your forgotten 401(k)'s provider and inform them of your decision to rollover to an IRA. They will provide you with the necessary paperwork or guidance on initiating the rollover process.

4. Complete the rollover paperwork. If needed, fill out the required forms provided by your 401(k) provider accurately and thoroughly. Make sure to include all necessary information to minimize any delays or complications.

5. Consider a direct rollover. Ask your professional advisor if you should opt for a direct rollover to avoid potential tax implications or penalties. Typically, with a direct rollover, your 401(k) funds are transferred directly to your new IRA provider, ensuring a smooth transition without tax consequences.

6. Monitor the rollover process. Stay in touch with both your 401(k) provider and IRA provider to ensure a timely and successful rollover. Keep track of the progress and reach out for updates if needed.

Planning for Your Future Financial Security

One important consideration is the option of a pension rollover to your 401(k). If you have a pension plan from a previous employer and you’re given the option, exploring the possibility of rolling it over into your 401(k) can be a wise move. A financial advisor can help you analyze which option is best for you  

regularly reviewing and adjusting your investment strategy is crucial. If your circumstances change, revisit your retirement savings and investment strategy. Keep a close eye on market trends and economic conditions, and make any necessary adjustments to your portfolio. This helps ensure that your investments are aligned with your long-term goals and can help you minimize risk.

If you want to discuss rollovers, retirement, or your financial future with a qualified financial advisor in Orange County, give us a call. We'd love to talk with you.