Seven Reasons to Rollover Your 401k into an IRA

February 8, 2016

After retirement, you may need to decide whether you should rollover your 401(k) to an individual retirement account. Once you are no longer working at a company, it may be a good idea to move your money to a retirement account that is not tied to your former employer. Here are a few reasons to rollover your 401(k) to an IRA:

Cashing out may be a bad idea
On each withdrawal, you’ll have to pay tax (marginal rate) on the lump sum and may have to pay a 10 percent penalty if you’re younger than 59 1/2. It may be better to take distributions over many years to minimize the tax. Delaying withdrawals as long as you can also will give your retirement fund more time to grow. You can eliminate the penalty in certain situations. If you are in a high tax bracket, this could be over 50% when you include federal taxes, state taxes, and federal penalty if under 59 ½.

Exceptions to the Early Distribution Penalties
You do not have to pay the additional 10 percent tax penalty on your early retirement distribution if you qualify for certain exceptions. There are two sets of exceptions. The first set below applies to individual retirement accounts (both traditional and Roth IRAs). The second set of exceptions applies to 401(k) and 403(b) retirement plans.

Exceptions for Early Distributions from an IRA:

  • You had a “direct rollover” to your new retirement account,
  • You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days,
  • You were permanently or totally disabled,
  • You were unemployed and paid for health insurance premiums,
  • You paid for college expenses for yourself or a dependent,
  • You bought a house,
  • You paid for medical expenses exceeding 7.5 percent of your adjusted gross income, or
  • The IRS levied your retirement account to pay of tax debts.

Exceptions for Early Distributions from a Qualified Retirement Plan such as a 401(k) or 403(b) plan:

  • Distributions upon the death or disability of the plan participant.
  • You were age 55 or over and you retired or left your job.
  • You received the distribution as part of “substantially equal payments” over your lifetime.
  • You paid for medical expenses exceeding 7.5 percent of your adjusted gross income.
  • The distributions were required by a divorce decree or separation agreement (“qualified domestic relations court order”). Visit www.irs.gov for Exception Conditions.

Typically lower fees
Your 401(k) plan has administrative fees that can cut into your investment returns over the years. If you rollover your money to an IRA, you may be able to pay fewer expenses, especially if you don’t sign up for investment management at a large brokerage firm or rollover to a variable annuity. Variable annuities are the investment options in many retirement plans and may not be the best choice. I have seen fees on variable annuities that were as high as four percent. So if you have $250,000 in your 403(b) variable annuity, you may pay over $100,000 in fees over the next 10 years. The fees with some investments can be as high as three to four percent.

A study by Economic professors Edelen, Evans and Kadlec found U.S. Stock Mutual Funds average 3.17 percent in a non-taxable retirement account.

The majority of 401(k)s are invested in mutual funds:
http://www.forbes.com/2011/04/04/real-cost-mutual-fund-taxes-fees-retirement-bernicke.html

More control
Most 401(k) plans have restrictions for withdrawal. If you have your funds in an IRA, you can withdraw for your child’s college and not pay the 10 percent penalty. If in a 401(k) this is not true, your employer will most likely only allow this if you take a loan or a hardship withdrawal, which can be very difficult to get sometimes. If you want to convert your IRA to a ROTH IRA, you can do so but not while still in a 401(k).

Employer stock
It’s hard to believe, but many workers still have a large portion of their 401(k)s invested in their employers’ stock. Some companies invest their employer contribution directly into company stock. This is could be a bad idea, because there are too many eggs in that basket. If your employer goes out of business, you could lose not only your job but also your retirement savings.

It may not be a good idea to rollover your 401(k) if you have highly appreciated company stock inside your 401(k). Before you sell the company stock inside your 401(k), you may want to consider Net Unrealized Appreciation (NUA). It is simply a way to remove the stock from your 401(k) without rolling it to an IRA. Speak with a tax professional to see if NUA could save you on taxes before your roll your 401(k) to an IRA.

  • You leave the plan and roll your stock into an IRA.
    If you choose this option, you’ll pay no tax when you move your investments into an IRA, if you do a trustee-to-trustee transfer. But when you take the money out at retirement, all of it will be taxed at income tax rates (which could be nearly twice as high as capital gains rates).
  • You leave the plan and roll your stock into a brokerage account, or you stay in the plan and take your lump sum distribution at retirement.
    In either case, you move all the company stock from your 401(k) into a non-IRA taxable account. When you pay that year’s taxes, you’ll owe income tax on the total that you actually paid for the stock. But when you take money out of the account at retirement, you’ll pay tax on your earnings at capital gains rates (typically less than the income tax rate).

Better investment choices
Most 401(k) plans have very limited investment choices. Unfortunately, many of these mutual funds have high fees and high expense ratios. Some investors might want to invest in individual stocks, bonds, commodities, ETFs (Exchange Traded Funds), and/or ETNs (Exchange Traded Notes), and that’s easy to do in an IRA.

Consolidate and simplify
It is possible for some workers who frequently change jobs to end up with several 401(k) accounts if they don’t roll them over. It’s much easier to check on your investments if they are in one IRA instead of many 401(k)s. A single IRA also makes it much easier to revamp your investments. You may be surprised at how much you are paying in fees as your 401(k) balance grows.

There are many things to deal with when you leave your job or career, but don’t forget about your retirement account. This could be your largest investment if you work with one employer for a long time. Contact us by clicking here if you want a true retirement analysis completed. This free report will show you the current fees you are paying and give you many more investment options.

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