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When you retire or leave an employer, one of the decisions that often comes up is what to do with your 401(k). You can generally leave the money in the plan, roll it into an IRA, move it into another employer’s retirement plan, or take a distribution.
An IRA can give you more investment flexibility and make it easier to consolidate your retirement accounts. At the same time, your existing 401(k) may have low-cost investments, useful withdrawal provisions or other features worth keeping.
There isn’t a universal answer. Before moving the money, consider these seven questions.
1. What will I gain by moving my 401(k)?
An IRA generally gives you access to a much broader range of investments than an employer retirement plan. It can also provide more flexibility in how those investments are combined and managed, which can be particularly useful for higher-net-worth households with multiple account types, tax considerations and sources of retirement income.
There can also be a meaningful difference in the technology and day-to-day experience of managing the account. Large investment custodians such as Schwab and Fidelity typically offer more robust websites, mobile apps, account dashboards, research tools and transaction capabilities than the recordkeeping platforms used by many employer retirement plans.
An IRA can also allow for considerably more customization. Rather than choosing from a limited menu of investments within a 401(k), you may have greater flexibility to coordinate investments across taxable, traditional IRA and Roth accounts, manage different tax exposures and structure the portfolio around your broader retirement strategy. That flexibility can become increasingly valuable as the complexity and size of a household’s finances increase.
More choices and better technology don’t automatically mean an IRA is the better option, but the advantages of an IRA are more meaningful than simply having access to a longer list of investments. IRA investors today have access to an enormous range of low-cost investment options, and low fees are widely available across the industry. For many retirees, the greater flexibility to customize and coordinate investments across accounts can be more important than the difference between two low-cost investment options.
Compare the investments, expense ratios, administrative fees and advisory costs, along with how much flexibility you actually need. The value of an IRA isn’t simply having more investment choices. It’s having greater flexibility to coordinate the account with the rest of your financial picture.
2. What could I lose by leaving the 401(k)?
Your 401(k) may have features that you would lose by moving the money.
One example is the Rule of 55. Under certain circumstances, someone who separates from service during or after the year they reach age 55 can take distributions from that employer’s 401(k) without the 10% additional tax that would otherwise apply before age 59½.
That can matter if you retire before 59½ and expect to need access to your retirement savings.
Before moving the money, determine whether your current plan offers a withdrawal provision that you may want to preserve.
3. Does my 401(k) contain company stock?
If you own appreciated employer stock inside your 401(k), don’t automatically roll everything into an IRA.
Certain employer stock may qualify for a tax strategy called net unrealized appreciation, or NUA. Under the right circumstances, the appreciation in qualifying employer securities can receive capital-gains treatment when the stock is eventually sold rather than being treated entirely as ordinary income.
NUA isn’t appropriate for everyone, and the rules can be complicated. Once qualifying company stock is rolled into an IRA, you generally can’t use the same NUA strategy for that stock.
If your 401(k) contains company stock, review that position before initiating a rollover.
4. How will the rollover affect my taxes?
A properly completed direct rollover from a traditional 401(k) to a traditional IRA generally isn’t taxable at the time of the rollover. The mechanics matter, however.
If the retirement plan sends the distribution directly to the receiving IRA or retirement plan, you can generally avoid the mandatory 20% withholding that applies when an eligible plan distribution is paid directly to you.
If the distribution is paid to you instead, you generally have 60 days to complete the rollover. Because 20% is generally withheld from an eligible plan distribution paid to you, you may need to use other funds to roll over the full amount and avoid having part of the distribution treated as taxable.
If you’re retiring, you may have several years when your taxable income looks very different from when you were working. Those years can create opportunities for Roth conversions and tax-efficient withdrawals, so the rollover should be considered as part of the larger tax strategy.
5. Am I planning to do Roth conversions?
The years between retirement and required minimum distributions can be an important part of a long-term tax plan.
For some retirees, gradually converting portions of traditional retirement assets to a Roth IRA can make sense while taxable income is lower. The amount converted each year can affect your tax bracket and other income-related costs.
A rollover from a 401(k) to an IRA can fit well into that strategy, but it can also create complications depending on your existing IRA balances and what you plan to convert.
Instead of asking only whether you should move the 401(k), consider how the account will fit into your tax strategy over the next several years.
6. Would consolidating my retirement accounts make life easier?
Over a career, it’s common to accumulate retirement accounts at several different institutions. You may have an old 401(k), another former employer’s plan, an IRA, a Roth IRA and taxable investments.
Each account can mean another login, another password, another set of statements, different beneficiaries and potentially another set of tax documents to keep track of.
Managing several accounts may not seem difficult at 55, but keeping up with multiple institutions, passwords and tax documents can become a real administrative burden later in retirement. It can also make things more difficult for a spouse or family member who eventually needs to help manage the household finances.
There is another practical consideration: how easy will it be to get your money out?
Some employer retirement plans can be cumbersome once you begin taking distributions. Setting up recurring withdrawals, changing tax withholding, requesting a different distribution amount or dealing with the plan’s recordkeeper may involve forms, phone calls or procedures that are less convenient than managing a consolidated IRA.
That doesn’t make an IRA automatically better. A good 401(k) can have excellent investment options and valuable plan features. But it’s worth considering how easy the account will be to manage after you retire, not just how well it served you while you were working.
7. What job will this money do in retirement?
Your 401(k) becomes one source of income alongside Social Security, taxable investments, Roth accounts, pensions and other assets.
Consider someone with $2 million in a 401(k), $500,000 in a taxable portfolio and substantial Social Security income. Their withdrawal strategy may look very different from someone whose 401(k) represents nearly all of their retirement savings.
The investment strategy, tax strategy and withdrawal strategy should work together. Sometimes an IRA makes that easier. In other situations, keeping some money in the 401(k) can make sense.
The account itself isn’t the retirement plan. It’s one part of it.
Should I roll over my 401(k) when I retire?
There are good reasons to consider a rollover, but there are also good reasons to keep money in a former employer’s plan.
An IRA may provide broader investment choices, easier consolidation and greater control over how retirement assets are managed. A 401(k) may offer low-cost investments or withdrawal provisions that are valuable in your particular situation.
The decision should also account for company stock, Roth conversions, fees, taxes and how you expect to generate income throughout retirement.
Before moving the money, look at what you’re gaining, what you’re giving up and how the account fits into the rest of your retirement plan.
Key Takeaways
- You don’t have to roll over your 401(k) when you retire.
- Compare investment choices, expenses and advisory fees before deciding that an IRA is automatically better.
- Consider the Rule of 55 before moving money out of a 401(k).
- Review company stock for potential NUA treatment before initiating a rollover.
- A direct rollover can help avoid unnecessary withholding and tax complications.
- Roth conversion planning should be considered before moving a large 401(k) balance.
- Consolidating accounts can reduce the number of logins, passwords, statements and tax documents you have to manage.
- Consider how easy the account will be to manage once you begin taking retirement distributions.
- The rollover decision should fit into your broader retirement income and tax strategy.
About the Author
Gabriel Motta, CFP®, MBA, is the founder and principal of Inclinevest Wealth Management, a fee-only fiduciary retirement financial advisor and financial planner based in Greenwood Village, Colorado. He works with high-net-worth pre-retirees and retirees throughout south Denver, across Colorado, and nationally, including clients in Highlands Ranch, Centennial, Lone Tree, Aurora, Parker, Castle Rock, and Littleton, with particular experience serving aerospace and defense professionals in Colorado and nationwide. As a retirement planner and wealth manager, Gabriel helps clients navigate retirement income planning, Social Security strategy, tax-efficient withdrawals, and equity compensation. Gabriel is a NAPFA and XY Planning Network member. Learn more about Gabriel and Inclinevest Wealth Management (https://www.inclinevest.com/about-inclinevest-denver/) or schedule a conversation (https://calendly.com/inclinevest/inclinevest).
Sources
- Internal Revenue Service, “Rollovers of Retirement Plan and IRA Distributions,” irs.gov
- Internal Revenue Service, “Publication 575, Pension and Annuity Income,” irs.gov
- Internal Revenue Service, “Retirement Plans FAQs regarding IRAs,” irs.gov
This article is for general informational and educational purposes only. It isn’t personalized investment, tax, or legal advice, and it shouldn’t be relied on as a substitute for guidance specific to your situation. Inclinevest Wealth Management is a registered investment adviser. Registration doesn’t imply any level of skill or training. Please consult a qualified professional before making decisions about your own financial circumstances.
