10 Items You Need to Know Before Rolling Over Your 401(k) or Company Sponsored Retirement Plan
A crucial element of retirement planning is deciding what to do with your assets in company sponsored retirement plans when you retire or change your employment status.
We all look forward to the day we can finally access our hard-earned retirement savings, whether by voluntary retirement, inheritance, or other means. However, rushing the transition from accumulating to withdrawing funds from an employer-sponsored retirement plan can potentially lead to costly tax consequences. Planning for this transition is essential for maximizing your retirement benefits.
If your employer requires distribution of your 401(k) or other employer-sponsored plan funds upon leaving, rolling it over to an IRA may be the only option available to avoid unnecessary taxes and, depending on your age, and other considerations. For instance, taking a lump sum distribution from your employer-sponsored retirement account could push you into a higher tax bracket, or cause penalties, thus increasing your tax burden.
To continue to grow and defer taxes, many prudent investors opt to “roll” employer retirement funds to an IRA. It can give investors more control over when and how to invest the funds, and to some extent, when and how to take distributions. In addition, if you have multiple retirement plan accounts at more than one past employer, it can cause management headaches down the line, and consolidating them into an IRA can not only make them easier to manage, but may help you qualify for reduced costs.
That said, many employers allow retirees to leave funds in the company’s retirement plan. Given the option to leave funds in an employer plan, or roll it into your own IRA, which should you choose?
The answer to this, as with most personal finance questions, is that “IT DEPENDS!” Everyone’s situation is different. Below are 10 factors to consider when making this decision for yourself.
10 Key Factors for 2024 Rollovers
- Penalty-Free Withdrawals: Employees who leave a company between age 55 and 59½ can typically take penalty-free withdrawals from an employer plan. In contrast, penalty-free withdrawals from an IRA generally aren’t allowed until age 59½, unless you qualify for certain exceptions.
- Loan Access: Many employer-sponsored retirement plans allow employees to take loans against their retirement funds, with limitations. IRAs, however, generally do not allow for loans or collateralization, so if you rely on this feature, it may be best to keep funds in your employer plan.
- Protection from Creditors and Legal Judgments: Employer plan assets are typically protected from creditors under federal ERISA laws, whereas IRA may only be protected in certain bankruptcy proceedings and are subject to State law protections for liability. State laws vary in their protection of IRA assets.
- Required Minimum Distributions (RMDs): The SECURE Act 2.0 raised the age for RMDs to 73 in 2023, with another increase to 75 coming in 2033. If you’re still working for your employer at the RMD age, you may not be required to take distributions from your current employer’s plan, allowing you to defer income taxes longer. In contrast, RMDs are required for traditional IRAs once you reach the specified age, regardless of your employment status.
- Employer Stock: If you hold employer stock within your employer retirement plan, please tread carefully. Not only might it be a concentrated position potentially carrying unnecessary risk, but if it has appreciated, you should be aware of a possible tax reducing strategy. The consequence of simply rolling the appreciated stock to an IRA or keeping it in the plan is that distributions will be taxed as ordinary income, just like any other asset distributed. However, if a rollover meets certain requirements, you might only be required to pay capital gains tax (as opposed to ordinary income tax) on the difference between the appreciated value of the stock when you sell it and your cost basis, which can significantly reduce your tax burden on the appreciated employer stock.
- Investment Options: IRAs generally provide a wider range of investment options than employer-sponsored plans. Although the flexibility of an IRA can offer tailored investment strategies, it can also introduce complexity. If your employer plan has limited or costly options, rolling over may provide more effective investment choices aligned with your long-term goals.
- Services: The level of service for employer plans and IRA providers varies. Some employer retirement plans give access to general investment advice, planning tools, telephone help lines, online access, educational materials, and workshops. Similarly, many advisor-managed IRAs offer these as well, but may also offer a higher level of service, which could include more personalized investment advice, comprehensive financial planning, and estate planning, among other items. An evaluation of the services offered should be made in the context of the value provided and costs to the client.
- Fees and Expenses: Both employer sponsored plans and IRAs often involve underlying investment-related expenses and plan or account fees. Investment related expenses may include sales “loads,” commissions, holding period penalties, and investment advisory fees. Plan fees typically include administrative fees (e.g., recordkeeping, compliance, trustee) and service-related fees, such as access to customer service representatives. Typically, plan costs are shared by the employer and employees. IRA account fees may also include many of these fees. An investor should identify and understand all of the fees and expenses associated with their retirement plan account, as well as with any new strategy, whether a Rollover IRA or otherwise.
- Roth Conversions: For those interested in converting traditional retirement assets to Roth accounts, IRAs often provide greater flexibility for strategic Roth conversions, which can be done in phases to manage tax implications. Some employer plans may allow in-plan Roth conversions, but IRA rollovers are generally more conducive to controlled Roth conversion strategies.
- Consolidation and simplification: Rolling over retirement assets to a single IRA reduces the complexity of managing investments, tracking performance, RMD calculations, estate planning, and making informed decisions about your overall retirement strategy.
The above considerations underscore the importance of weighing all aspects before deciding between keeping funds in your employer plan or rolling them into an IRA. Other considerations might also apply to your situation. Therefore, consulting an experienced financial professional who understands the intricacies of these decisions can help you determine the best path based on your individual circumstances.