Are you thinking of consolidating multiple 401K’s, IRA’s and other retirement accounts? Here are the pros and cons along with a guide to consolidation.
If you have switched jobs, you may have multiple retirement accounts. According to the Government Accountability Office, approximately 25 million Americans left behind a 401K when they moved on from a job between 2004 and 2014. If you have several Individual Retirement Accounts (IRA’s), it may be tempting to consolidate. However, does consolidation make sense and how do you go about merging different plans?
Advantages of Consolidating Retirement Accounts
Convenience – By consolidating retirement accounts, it is less complicated to keep track of how much money you have, earnings and to take necessary tax deductions. Management is simpler and having fewer accounts makes estate planning easier.
Optimization – Consolidating multiple retirement accounts makes it easier to rebalance portfolios to optimize returns.
More Control – Current law allows employers to move old 401K accounts that have less than $5,000 into an IRA if the former employee does not move the money voluntarily. Employers also have the option of cashing out those small balances and sending a check. By rolling your old 401K’s into an IRA, you maintain more control over your investment.
Withdrawals – By having all of your retirement savings in one account, rather than spread out in multiple funds, the balance is larger and you are less likely to want to take money out. However, if you do need to withdraw money for hardships reasons, a bigger balance means the ability to take out a bigger loan.
Fees – By not consolidating retirement accounts, you potentially run the risk of keeping your funds invested in high cost mutual funds. In addition, with IRA’s, more funds typically means that you are paying more in fees.
Avoid Minimum Required Distributions – With each 40K, you are required to take a minimum distribution after the age of 70 ½ and pay taxes on the income. By rolling these funds over into an IRA, you are only required to take a single distribution. This not only allows you to keep more money in your retirement account to grow until you need to take a withdraw, it can allow save on taxes.
According to Terry Dunne, Millennium Trust Senior Vice President, rolling over old 401K accounts into a Roth IRA “retains the tax-advantage status of the assets, allows more choice of investments and allows you to remain in touch with your assets.’
Disadvantages of Consolidating Retirement Accounts
Credit Protection – While money in a “qualified retirement account”, such as a 401K, SEP or Simple IRA; is protected from creditors, money in a regular IRA is not. If you own a business or have other factors that put you at a higher risk for a lawsuit, it may make sense to not rollover those old 401K’s.
Lower Costs – Sometimes your old 401K plan may be in a higher earning, lower cost, mutual fund than your IRA or other retirement account. In that case, it makes more sense to keep your money where it is. In addition, by having an employer-sponsored 401K rather than an IRA through a bank or brokerage firm, you save on fees.
Less Access to Funds – If retirement accounts are consolidated, early retirees (before the age of 59 ½) will often lose the ability to withdraw money penalty-free. Early IRA withdrawals are taxed as income and subject to a 10% fee. If you have a 401K that allows partial withdrawals, you may want to keep your money there.
Limits on Contributions – As of 2020, you can only contribute up to $19,500 into a 401K account ($26,000 if over 50). The contribution limit for SIMPLE plans is $13,500. The yearly contributions to all of your traditional IRAs and Roth IRAs cannot be more than $6,000 ($7,000 if you are over 50). In addition, individuals with modified adjusted gross incomes above $206,000 (married filing jointly) or $139,000 (single) for 2020 cannot contribute to a Roth IRA. Although there is a “backdoor strategy” that allows high earners to convert or rollover the funds from a traditional IRA to a Roth IRA, they will have to pay taxes on the contributions and gains. If you are a higher earning individual that frequency “maxes out” your retirement accounts, it makes sense to keep multiple accounts and contribute to the limit for each one.
How to Consolidate Retirement Accounts
The general rule is it is easiest to consolidate like accounts – a traditional IRA into another traditional IRA. This chart explains what you can consolidate.
| Roth IRA | Traditional IRA | Simple IRA | SEP-IRA | Governmental 457b | Qualified Plan (pre-tax) | 403 b (pre-tax) | Designated Roth Account 401k, 403b, 457b | ||
| Roth IRA | Yes | No | No | No | No | No | No | No | |
| Traditional IRA | Yes | Yes | After 2 yrs. | Yes | Yes | Yes | Yes | No | |
| Simple IRA | After 2 yrs | After 2 yrs | Yes | After 2 yrs. | After 2 yrs | After 2 yrs | After 2 yrs | No | |
| SEP-IRA | Yes | Yes | After 2 yrs. | Yes | Yes | Yes | Yes | No | |
| Governmental 457b | Yes | Yes | After 2 yrs | Yes | Yes | Yes | Yes | Yes | |
| Qualified Plan (pre-tax) | Yes | Yes | After 2 yrs. | Yes | Yes | Yes | Yes | Yes | |
| 403b (pre-tax) | Yes | Yes | After 2 yrs. | Yes | Yes | Yes | Yes | Yes | |
| Designated Roth Account 401k,403b, 457b | Yes | No | No | No | No | No | No | Yes | |
There are caveats to these conversions, check IRS Rollover Chart for details.
While there are pros and cons of consolidating retirement accounts, what makes sense to you depends on:
- Your overall retirement strategy
- Your income and tax bracket
- What accounts offer the best rate of return
- What accounts offer the lowest management cost
Ideally, you want to keep as few accounts that offer the best rate of return while keeping fees to a minimum to maximize your earnings. Since retirement planning and tax strategy can be tricky with ever changing laws, you may want to consult a financial advisor.