Common question today: Should I Roll Over My 401(k)? In fact, it is about more than where to put assets. Additionally, retirees are learning they have multiple options today. When approaching retirement, one major financial decision may be easy to overlook.
Should I leave my money in my 401(k), or roll it over to an IRA?
Should I do a 401(k) rollover after retirement?
Should I leave my 401(k) with my old employer?
Should I just take a lump-sum distribution?
For many retirees, including those who live in Simi Valley and Moorpark with high real estate prices, a 401(k) may represent one of their largest financial assets.
After 30 or 40 years of saving, the balance can easily reach hundreds of thousands—or several million—dollars. One million dollars ain’t what it used to be.
Simply asking ‘where’ to move the account isn’t enough now. During retirement, you’re in the decumulation stage of life – living off assets instead of simply accumulating. Now the decisions become more connected – and mistakes become more expensive.
So, should you roll?
Rolling a 401(k) into an IRA can make sense, but it is not automatically the best choice. Before moving the money, compare your existing 401(k) with an IRA based on investment choices, costs, withdrawal flexibility, taxes, retirement income needs and several special rules you could lose by rolling over.
Sounds complicated, I know. But an independent professional should have state-of-the-art software that can run an objective analysis for you.
Why Retirees Roll Their 401(k)s Into IRAs
The most common reasons tend to be control and more choices.
During your working years, your employer determines which investments are available inside the 401(k). That may be perfectly adequate while you are accumulating money. After all, during this stage taxes are deferred and you don’t have to worry withdrawals impacting tax brackets, Medicare premiums, or taxes on Social Security.
Retirement changes your job description
Now the portfolio may need to produce withdrawals, help manage taxes, maintain enough growth to keep up with inflation and coordinate with Social Security, pensions and other investments.
And, it’s often true that an IRA generally provides access to a much broader range of investments than the menu offered by a typical employer plan. It can also make it easier to coordinate or even consolidate several old retirement accounts under one investment and withdrawal strategy – that can simplify your life.
That flexibility can be valuable. But flexibility by itself is not a reason to roll over.
The better question is:
What can the IRA accomplish that your current 401(k) cannot?
If there isn’t a good answer, moving the account simply for the sake of moving it may accomplish very little.
Should I leave my 401(k) with my old employer
When Leaving Money in Your 401(k) May Be Better – Some 401(k) plans are excellent.
They may offer very low-cost institutional investments, attractive fixed-income or stable-value choices, convenient administration and other benefits that may be difficult to duplicate elsewhere. Maybe. But, today professionals have access to all these. In some cases the cost may be less; but even where it’s the same or more the question is what value you’re receiving for the difference in cost. An advisor who saves you thousands due to tax management may be worth more than the cost difference.
There are also several situations where moving too quickly can create problems.
For example, certain employees who separate from service during or after the year they turn 55 may qualify for an exception to the 10% additional tax on withdrawals from that employer’s retirement plan. That exception generally does not transfer with the money simply because you rolled the account into an IRA.
This can be especially important for someone retiring in their late 50s who expects to use retirement-plan money before age 59½.
Employer stock deserves attention as well.
If your 401(k) contains significantly appreciated company stock, special net unrealized appreciation, or NUA, tax treatment may be available in certain circumstances. Rolling the shares into an IRA without evaluating that opportunity first can eliminate the ability to use the special treatment. A professional can help design an NUA strategy that will avoid the tax traps a simple rollover would create.
That would be a rather expensive way to discover that not all rollovers are created equal and that professional help may be worth more than a simplistic look at fees.
Don’t Look at the 401(k) in Isolation
This is where rollover decisions become more interesting for households approaching retirement.
Employer stock deserves attention as well.
If your 401(k) contains significantly appreciated company stock, special net unrealized appreciation, or NUA, tax treatment may be available in certain circumstances. Rolling the shares into an IRA without evaluating that opportunity first can eliminate the ability to use the special treatment. A professional can help design an NUA strategy that will avoid the tax traps a simple rollover would create.
That would be a rather expensive way to discover that not all rollovers are created equal and that professional help may be worth more than a simplistic look at fees.
Don’t Look at the 401(k) in Isolation
This is where rollover decisions become more interesting for households approaching retirement.
Suppose you retire with:
- $1.5 million in a 401(k)
- $400,000 in taxable investments
- Social Security benefits beginning in a few years
- A pension
- A paid-off or nearly paid-off home
The question isn’t merely whether the IRA offers better investments. The real question is how that $1.5 million fits into your retirement income and tax plan.
- Should some withdrawals come from taxable investments first?
- Could Roth conversions make sense during the lower-income years immediately after retirement?
- How much should remain invested for long-term growth?
- How will future taxable retirement distributions interact with Social Security taxation and Medicare premiums?
Those decisions are connected. Treating the rollover as an isolated investment decision can miss the bigger opportunity.
Should I Roll Over My Entire 401(k)?
Not necessarily. Retirement decisions don’t always have to be all-or-nothing.
Depending on the rules of your employer plan, there may be circumstances where keeping part of the money in the plan while moving another portion elsewhere makes sense.
Your 401(k) may also contain different types of money—traditional pretax contributions, Roth contributions, employer contributions and possibly after-tax contributions.
Those distinctions matter.
IRS rules can allow pretax and after-tax portions of certain distributions to be directed to different destinations. For example, qualifying after-tax amounts may potentially be directed to a Roth IRA while pretax amounts go to a traditional IRA or another eligible retirement plan.
This is one reason I generally prefer to understand what is actually inside the 401(k) before deciding where it should go.
If You Do Roll Over, Use the Right Method
If the decision is made to move the account, a direct rollover is generally the cleanest approach. With a direct rollover, the retirement-plan assets are sent directly to the receiving IRA or retirement plan.
If instead the distribution is paid directly to you, an employer retirement plan generally must withhold 20% for federal income taxes. You normally have 60 days to complete an eligible rollover, and replacing the amount withheld may be necessary if you want the entire distribution treated as rolled over.
Why complicate things? There is rarely a prize for making this part more complicated than necessary.
Five Questions to Ask Before Rolling Over a 401(k)
Before moving the account, I would want answers to these questions:
- What am I giving up by leaving my existing 401(k)?
- What will the IRA allow me to do that the 401(k) doesn’t?
- What will my total investment and advisory costs be under each choice?
- Will I need access to this money during the first several years of retirement?
- How does the rollover fit with my tax, Roth-conversion and retirement-income strategy?
For larger accounts, I would add a sixth:
Is there employer stock, after-tax money or another special provision that needs to be evaluated before anything moves?
That’s often where the expensive mistakes hide.
Before you authorize the rollover
- Do you own company stock?
- Are you retiring before 59½?
- Does the account contain after-tax contributions?
So, Should You Roll Over Your 401(k) When You Retire?
For many people, an IRA provides greater flexibility and can make it easier to coordinate investments, withdrawals and tax planning.
For others, leaving some or all of the money in the 401(k) is the better choice.
The decision should come before the rollover—not afterward.
Ready, fire, aim rarely leads to good outcomes. So, whether you’re someone local in Simi Valley or Moorpark – or anywhere else – who is approaching or in retirement and have accumulated a substantial 401(k), don’t begin by asking, “Where should I move the money?”
Begin with:
“What do I need this money to do for me during retirement?”
Once you answer that, the rollover decision usually becomes much clearer.
Not Sure Which Direction Makes Sense?
I’ve created The 401(k) Rollover Decision Tree to help you work through the major questions before deciding whether to leave your retirement savings in your employer’s plan or move them to an IRA.
It won’t make the decision for you. It will help you identify the issues worth looking at before you make an irreversible or potentially costly move.
Download The 401(k) Rollover Decision Tree
I hope you find it helpful. If I can be of help, let me know!
Jim
