After many years of saving to your company retirement plan, you finally see the light through the end of the tunnel.  Retirement is near, and there is no shortage of advice from friends, colleagues, and family.  Here are some important points to consider as you decide whether or not to rollover your 401(k) to an IRA.

6 Reasons to Roll the Money out of the 401(k)

  1. If you leave the money in the 401(k), once you pass away, the company plan may require your survivor to move the money out of the plan in 1 year or 5 years. Company plans do not want to keep track of beneficiaries of deceased employees.  These rules mean the end of deferred taxes for your loved ones.   A beneficiary of an IRA may benefit from a longer stretch (now 10 years for non-spouse beneficiaries and a lifetime for your spouse, as a result of the newly passed SECURE Act).   You may think to yourself, “fine, I will leave the money in the plan and then at my death, my loved ones can roll it over to an IRA.”  True, but the company plan can be a bureaucracy that may mess up the transfer.  Once the money is in the IRA, it is a lot simpler for your survivors to make the transfers.  If the funds stay in the plan, your beneficiaries could be cashed out and taxed in 5 years at best.
  2. Within a company plan, there are very often a limited number of investments that were chosen by the HR department. Often, these choices do not allow you to hold a properly diversified portfolio, lacking certain asset classes altogether, which is very important for efficient returns that match your risk tolerance.  Also, most or all of the investment choices may belong to a certain fund family or company and you are limited to those choices.  Many plans offer investment choices that charge the investor a higher cost than they would like.  These charges are known as “expense ratios” and represent the cost of holding the investment, running on average 1%, which is not inexpensive, eating up a chunk of your returns over time.  In addition, there are participation fees that each participant pays for the administrative costs of the plan.  Often, the service you receive from the inexperienced phone rep at the company plan is not ideal and may come from a sales perspective.  An IRA of your choosing allows you to select from the universe of investment options with the help of a trusted fiduciary advisor who puts your best interests first.
  3. If you have money in the company plan, and money outside of the company plan, you will have more than one statement to track.  More than one statement makes it more difficult to ensure that all your money is diversified and working together as a whole.  Also, are  you getting necessary financial planning with the 401(k) representative that includes all of your investments?  When you reach the age for Required Minimum Distributions (now age 72, thanks to the SECURE Act), you will have to remove one RMD from the company plan and another from the IRA’s.  You are not allowed to remove money from the IRA’s alone, even if it is the correct amount for your entire balance together, as 401(k) plans each require their own separate RMD.
  4. Company 401(k) plans are mandated to withhold 20% income tax from your withdrawal. IRA’s are not.
  5. If you hold a significant amount of company stock within your company plan, you can benefit from some important tax advantages that save you on income taxes. The advantage is referred to as the NUA (Net Unrealized Appreciation) stock rules.  For example, to be taxed at the much lower capital gains tax rate on the appreciated company stock rather than the higher ordinary income tax rate, you must adhere to all the rules to obtain this benefit.  One of the necessary steps is to empty the company plan to zero by rolling the company stock out of the plan to a non-IRA account and rolling all of the other money that is not company stock to an outside IRA in one calendar year after eligibility.  Leaving the money in the company plan means that you cannot make any withdrawal without emptying the entire balance by the end of the calendar year, or you forfeit this tax advantage.   The tax advantages of this rule can be significant.
  6. Roth options. Your company plan may not offer a Roth contribution option or the ability to make Roth Conversions.  If tax planning is important to you, it may be necessary to roll the money out of the plan to an IRA.


5 Reasons to Leave the Money in the Company Plan

  1. Federal Creditor Protection is granted by ERISA laws that govern company plans. In general, your company plan protects your assets from creditors, even in non-bankruptcy situations.  The same can be true for IRA’s, depending upon the state in which you live.  In Texas, for example, there is strong creditor protection for money inside of an IRA, so this may not be an issue.  You will want to check your own state creditor laws if creditor protection is important to you.
  2. If you cannot qualify for life insurance on your own, but you can qualify for life insurance inside of the company 401(k) and the company plan offers you that option, you many want to keep the money inside of a company plan that is invested in life insurance. You are not allowed to purchase life insurance within an IRA.  If you do own life insurance inside of the company plan, and at retirement you would like to roll your money to an IRA, you could surrender the policy with the money going to the company plan which could later be rolled over to an IRA.
  3. Will you be working beyond age 72? If so, you may want to leave your assets inside the company plan, as there is a “still working” exception to the Required Minimum Distribution rules if you are still working for the company and are not an owner of the company.  If you plan to leave your current employer where your 401(k) resides, you can roll those funds to the new employer’s 401(k).  IRA’s do not have the “still working” exception to RMD’s.  However, the new portability rules will allow you to roll any pre-tax IRA funds to the new company 401(k) plan to delay RMD’s past age 72.
  4. Are you over age 55 but under age 59 ½ and planning to separate from your employer? If you need to access your 401(k) money and are at least age 55 and leaving your job, you can take withdrawals from the 401(k) without paying the 10% tax penalty as long as it is in the year you turn 55, owing only the ordinary income tax on the withdrawals.  If you roll the plan money to an IRA, you will be subject to the 10% penalty, as IRA’s do not enjoy this Age 55 Plan exception (even SIMPLE or SEP IRA’s).   You must, however, be taking the withdrawals in the year of separation.
  5. Are you a Public Safety Employee and planning to separate from service?  For state and local public safety employees, you can withdraw from your employer plan penalty free, owing the income tax only on the withdrawal and no 10% tax penalty if you make the withdrawal in the year you separate from service, as long as you are age 50 or older that year.

If you have questions about your personal situation, please reach out and let us know.  We would be glad to help.


Michelle Gessner, CFP®