If you are leaving your job — because, for example, you are changing employers or retiring — you may need to decide what to do with your 401(k) account without triggering a taxable withdrawal. Unless your account balance is less than $5,000 (excluding rollovers from other accounts), you typically can keep the funds in your former employer's plan. You also may have the option to roll over your old 401(k) balance into your new employer's plan. Finally, you can roll over the funds into an IRA account.
STAY OR ROLL OVER?
Rolling over a 401(k) balance into an IRA can be appealing because IRAs — usually offered by financial services companies — can provide a greater variety of investment options. However, there are also drawbacks to such rollovers.
Before making your decision, weigh the following factors:
Fees
Investment fees vary widely, and they can have a big
impact on the performance of your retirement funds. Unfortunately,
they are easy to overlook because they come out of your returns.
Leaving your job may give you an opportunity to move your savings
into lower cost investments. On the other hand, some 401(k) plans
offer competitive fees, so be sure to compare the costs of your
various options.
Related Read: 401(K) Plan Early Access: How to Avoid Penalties
Your Age
If you are 55 or older but younger than 59½, there
may be an advantage to leaving funds in your former employer's
401(k) plan. Usually, if you withdraw money from a 401(k) or IRA
before age 59½, you are subject to a 10% penalty (on top of
ordinary taxes for withdrawals). However, a special rule allows you
to withdraw money from a 401(k) plan penalty-free before age
59½ if you leave your job at age 55 or older (50 or older
for certain public safety employees). If you roll over the funds
into an IRA, this option is lost.
Protection From Creditors
If you are concerned about creditors going after your
retirement savings, you will generally enjoy greater protection if
you leave your funds in a 401(k) plan. Under federal law, money in
401(k) plans and other qualified retirement plans is generally
protected from creditors, both in and outside of bankruptcy. Funds
rolled over from a 401(k) into an IRA are generally protected in
bankruptcy. Outside of bankruptcy, however, creditor protection for
IRAs is governed by state law, and the level of protection varies
widely from state to state.
Company Stock
If your traditional 401(k) plan invests in your former
employer's stock, you may miss out on a valuable tax planning
opportunity by moving your entire balance to an IRA. If you leave
company stock in the current plan, you likely can take advantage of
a technique under which the stock is distributed to a taxable
account and you are taxed at favorable capital gains rates on its
appreciation. However, if you roll over your entire balance into a
traditional IRA, future distributions will be taxed at ordinary
income rates — which may be significantly higher.
Withdrawal Flexibility
If you are looking for control over the timing of your
withdrawals, you may want to roll over your balance into an IRA.
Many 401(k) plans prohibit partial or periodic withdrawals, so if
you plan to spread withdrawals over time, a rollover can be your
best bet.
NO PRESSURE
After you have left a job, there is generally no need to make a quick decision about an existing 401(k) balance. The best course is to leave your savings in your former employer's plan and take time to review your circumstances and discuss all of your options with your financial advisor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
