Should you rollover your 401(k)?

Should You Rollover your 401(k) into an IRA?
If you lose a job, change jobs or retire, few decisions are as important – or as complicated – as what to do with your 401(k) plan assets.

Leaving your job, getting laid off, or retiring can all be stressful situations. There are many lifestyle and other issues to think about, but few decisions are as important as what to do with your 401(k) plan money with your former employer.

In most cases, job-changers have at least two, and up to four, different options:

1. Take the money out.
2. Leave the money where it is – with the former employer.
3. Roll the money over into the plan of your new employer.
4. Roll the funds over to a rollover IRA.

Taking the money now. Generally speaking, this should be the choice of last resort. If you are younger than age 55 (in the case of a “separation from service”), you will generally be subject to income taxes at your ordinary rates, plus a 10% “early withdrawal” penalty. There are some circumstances under which the penalty can be waived, but if you are seriously considering a withdrawal it would be best to seek a qualified professional for advice. In most cases, the penalties plus tax will take a very large piece of the nest egg. The investor will not only be left with very little principal, but will also have lost the opportunity to benefit from continued, compounded tax deferrals.

Rolling the money into the plan of your new employer. Clearly, this option assumes there is a new employer – so this is not an option for those who are unemployed, have become self-employed, or are retiring completely. And the new employer has to have 401(k) plan that accepts rollovers. Beyond that, your funds are subject to many of the same drawbacks of keeping it where it is, and there are very few cases where there is any compelling benefit to rollover your assets into the new employer’s plan.

More typically, the choice most ex-employees face is leaving the money where it is vs. a rollover to an Individual Retirement Account (IRA). Here are the pros and cons:

The Pro’s: Reasons to rollover to an IRA:

1. IRAs provide greater freedom all around. When money is inside a plan, it is subject to tax laws and plan rules. Believe it or not, some plans can be more restrictive than the federal government says they need to be! And there are plan trustees and administrators – someone who works for your ex-employer and not for you – who acts as a gatekeeper for your funds. For example, if you did need to withdraw funds for a personal emergency — deciding that for whatever reason it was absolutely necessary – an IRA gives you immediate access to your funds, vs. getting it out from your old plan which would require paperwork and time.
2. More flexible investment options. IRAs can invest in almost anything: stocks, bonds, limited partnerships, etc. Most 401(k) plans offer a limited selection of 15 to 20 mutual funds. In addition, many plans limit your ability to reallocate among funds. In an IRA, you can trade and invest whenever and as frequently as you like
3. Beneficiary flexibility. Company plans are subject to federal laws about beneficiaries. Most plans requires a spouse as beneficiary, unless the spouse signs a waiver. IRA beneficiaries can be anyone you so designate, and can easily be split or earmarked for charity upon your death.
4. Stretch distributions for your beneficiaries. Because of the flexibility in beneficiaries, IRA money can easily be set up to keep growing over the lifetime of your heirs, deferring taxes and increasing compounding. Most 401(k) plans are going to get paid directly to your beneficiary. A spouse can roll this amount over, but often non-spouse beneficiaries cannot.
5. Fees. Depending on the plan, you may be paying investment advisory and fees for other services to the plan as a whole, and this may not be readily transparent. In some cases these fees may be paid by the employer; other times they are assessed to plan participants in full or in part, and the assessment is allocated among participants based on account value. So, if you had a significant nest egg in the company plan, you may be bearing a significant fee load. IRAs of course have fees but they are assessed only for services relating to your specific account, and they are typically quite clearly delineated.
6. Roth conversion option. An IRA is only subject to the tax rules on these. 401(k) funds will need plan provisions in place to convert those existing funds to Roth, if appropriate.
7. Access to professional, separate account management. With an IRA, investors have access to customized professional money management. 401(k) plans tend to be one-size-fits-all plans, and those with significant assets can often fare better working with a competent manager.

The Cons: Caveats to consider if you are thinking of rolling over your 401(k):

1. Creditor protection. State laws vary, but money in company-sponsored plans may often be better sheltered from creditors in litigation, divorce and other circumstances. If this is a concern for you, seek professional advice before rolling over any assets.
2. RMD exemption for those over 70.5 yrs old and still working. Money in company plans does not need to be distributed out in this case, whereas IRA money does.
3. Penalty waiver between age 55 and age 59.5. Money taken out from a company plan after a “separation of service” will not be subject to the penalty after age 55. If that same money is in an IRA, the penalty doesn’t get waived until 59.5. (It is subject to income tax in both cases).
4. Ability to borrow. Many (not all) company plans have provisions allowing participants to borrow. These privileges may not extend to ex-employees however. IRA borrowing is never allowed. Borrowing from retirement funds is generally not advisable, but if you require this ability, think twice.
5. Investments in your former employer’s stock. Special tax treatment exists when such stock is distributed out of a 401(k) plan. If you are holding company stock in your 401(k) plan, seek professional advice before enacting a rollover.

Deciding whether, how and when to rollover 401(k) funds into an IRA is complicated. In many cases, there are significant advantages to doing an IRA rollover. However, as with any significant financial decision, consult a professional financial adviser before making any moves.

Advertisement