Ask an Advisor: Does Converting $10k at a Time From My 401(k) to an IRA Make Sense in Retirement?

Ask an Advisor: Does Converting $10k at a Time From My 401(k) to an IRA Make Sense in Retirement?

Michele Cagan, CPA

7 min read

I retired in 2022 at 62 years old. I have a $2,900 monthly pension and draw $1,900 per month in Social Security. I have $520,000 in my 401(k) and $24,000 in an IRA. I currently move $10,000 from my 401(k) to my IRA every time it increases $10,000 in value. Is it wise to do this or should I let the 401(k) grow until I have to take my mandatory RMD? The IRA is 100% cash and is used for emergencies only. I don’t really have any large bills other than a HELOC and a car payment ($700 per month combined). Health insurance is currently costing $580 per month but Medicare will be available in six months.

-Neal

There are many good reasons for rolling over money in a 401(k) to an IRA or converting portions of a 401(k) into a Roth IRA. However, keeping the full balance of an IRA in cash may undermine some of the benefits of its tax-deferred growth. If you don’t need that money to cover regular monthly expenses, it may serve you better by keeping it invested in your 401(k). You’ll eventually have to take required minimum distributions (RMDs) from all traditional retirement accounts – both 401(k)s and IRAs – whether you need the money or not.

Keeping that money in cash and not investing it could result in lost earnings and diminished purchasing power over the years. Funding a separate emergency fund with any disposable income you have and keeping it in a regular taxable account (such as a high-yield savings account) could serve the same function while allowing your retirement accounts to continue to grow tax-deferred. Giving your retirement savings as much time to compound and grow gives you the best chance for enjoying a more financially comfortable retirement.

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While you’re working for an employer that offers a 401(k) plan, it makes good financial sense to contribute to the plan – especially if the employer offers matching contributions. But once you’re no longer at that job, it can be financially beneficial to move the balance of your 401(k) into an IRA.

The advantages of making this move can include:

more investment options

more control over your retirement account

reduced costs

low- or no-fee trades inside the account

direct access to account information

optional tax withholding on withdrawals

Once you’ve decided to move money from a 401(k) into an IRA, you’ll have two options: roll it over to a traditional IRA or convert it to a Roth IRA. Direct rollovers to traditional IRAs are tax-free transactions, but eventual withdrawals will be subject to income tax. Converting to a Roth IRA will result in a current tax bill on the full amount that’s converted, but qualified withdrawals will be tax free. (Talk to a financial advisor to determine which options makes the most sense for your unique situation.)

Either way, there are plenty of reasons to move your 401(k) into an IRA and preserve the tax advantages that come with retirement accounts.

Taking Advantage of Tax-Advantaged Accounts

Tax-deferred growth is the biggest benefit of saving in tax-advantaged retirement accounts. This allows your money to compound without an annual tax drag, letting the balance increase more quickly. Over the long term, this can lead to a significant accumulation of wealth.

Retirement accounts let you shelter account earnings from current taxes. Investments with the highest growth and earning potential reap the biggest benefit from this tax treatment. Remember, you’ll need that nest egg to fund decades worth of expenses, so you want to give it as much time to grow as you comfortably can.

As you near your retirement age, it makes sense to keep a portion of your retirement accounts in low- or no-risk assets. This can protect the money you will need in the next few years from potential investment losses when you won’t have time for the investments to recover. However, keeping too much money in cash has the potential to undermine your financial security, even though that might seem counterintuitive.

(If you need help determining the right mix of investments and risk your retirement portfolio should have, consider speaking with a financial advisor.)

The Risk of Playing It Too Safe

Keeping retirement accounts in cash may seem like a safe strategy, but it can actually have the opposite effect. Cash may be safe from investment losses, but it’s not safe from the rising cost of living. Inflation eats away at the value of your money: what costs $100 today could cost more than $120 a decade from now. Each dollar you have buys a little bit less as prices rise.

That said, once you’re retired, you will want to keep some of your money in cash or cash equivalents.

Start by figuring out how much money you’ll need in the next three to five years to cover all of your living expenses. Next, figure out how much of those expenses are covered by existing sources of income, such as:

Other income streams (such as royalties or rental income)

Subtract this total income from your expected living expenses to figure out how much you’ll need to withdraw from your retirement accounts. Then, move that portion of your retirement account into no- or very low-risk assets like high yield savings accounts, certificates of deposit (CDs), Treasury securities or money market accounts. While this money likely won’t be growing as much as it would if it was invested in stocks, you’ll still want this money to earn as much interest as possible. Working with a trusted financial advisor can you help you optimize your investment mix to preserve the money you need in the short term and continue growing the money you’ll need for a secure future.

Bottom Line

Balancing the need for immediate cash and long-term growth is an important aspect of retirement planning. By carefully assessing your income streams and anticipated expenses, you can strategically allocate your retirement savings to ensure both security and growth.

Tips for Finding a Financial Advisor

If you’re in the market for a financial advisor, there’s a lot that goes into finding the right professional to work with. Start by learning about the various types of advisors, as well as the services they provide, how they’re compensated and the types of questions you should be asking to vet potential matches. This process can feel overwhelming, which is why SmartAsset put together a comprehensive guide for how to find and choose a financial advisor.

Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

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Michele Cagan, CPA, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email [email protected] and your question may be answered in a future column. Questions may be edited for length and clarity.

Please note that Michele is not a participant in the SmartAsset AMP platform, nor is she an employee of SmartAsset. She has been compensated for this article.