By Dana Anspach, CFP, RMA
When you leave an employer, you have the option of rolling your 401(k) plan over to an IRA, or in some cases, you have the option of making an “in-service distribution” and moving a portion of your balance to an IRA while you are still employed. Post-employment, many plans also offer the option of leaving the funds in the plan, and if you are going to work for a new employer who offers a 401(k) plan you may be able to transfer your old 401(k) into the new plan.
Let’s examine the decision across four areas: timing, investment choices, administrative factors, and pricing. (Note we use the words 401(k), employer-plan and plan interchangeably.)
Timing: How Old Are You?
Did you leave your employer during or after the year you attained the age of 55 but before age 59½ (or for public safety workers, during or after the year you attained the age of 50)? If so, you qualify for a special rule that would allow you to take distributions without incurring the 10% early withdrawal penalty tax that normally applies to withdrawals prior to age 59½. Once you roll over funds to an IRA, this special early penalty-free access no longer applies. If you qualify for this “early retirement” rule, unless you have substantial assets outside the plan, Sensible Money often recommends leaving some or all your funds in the plan until you reach age 59½.
Investments: What Are Your Choices?
Does your plan offer unique investment options such as a stable value fund or fixed rate fund, sometimes referred to as GICs (guaranteed investment contracts)? These investment options have interest rates that are often superior to bonds or bond funds and such choices are not available outside of employer plans. If your plan offers such choices, Sensible Money may recommend you keep all or a portion of your investments in the plan to retain access to those investment types for the fixed income allocation of your investments.
Do you have employer stock in your plan? If so, you may have access to a unique distribution option called an NUA or net unrealized appreciation distribution where you can get preferential tax treatment on your stock by distributing it from the plan to a brokerage account. If you were to roll over your stock to an IRA, you would void this option. You will need to evaluate if an NUA distribution makes sense for you, and if it does, to qualify for preferential tax treatment, you must simultaneously distribute the stock and roll over the remainder of the balance to an IRA at specifically allotted points when it qualifies for this provision.
Many employer-sponsored plans offer a one-click option to rebalance. If you are not coordinating the allocation of your 401(k) plan with other accounts or if it is the only investment account you have, the convenience of one-click rebalancing is appealing. However, we find that most clients near retirement have multiple accounts and coordinating investments across numerous accounts is more easily accomplished when funds are consolidated into IRAs.
Employer plans may also change the investment choices or providers at any time. Each time this happens you must reevaluate the choices and how your portfolio is invested. This can be frustrating when you get everything just the way you want, and the plan forces you to change it due to the plan level changes. With an IRA you and/or your advisor are in control of the investment choices versus having a plan administrator make those choices for you.
Employer plans often lack access to asset classes such as small-cap value, emerging markets, international small-cap funds or other specialized fund types. Also, within a plan, you cannot purchase individual bonds or certificates of deposit. If you are building a long-term diversified investment plan you may need to roll over your funds to an IRA to get access to a broader array of choices that fit your investment needs.
Administration: What Are Your Custodian's Rules?
Many 401(k) plans require you to take distributions in a pro-rata fashion, which means you take proportionately from each underlying investment. This can be limiting. For example, if the equity market is down, you may wish to withdraw from a stable value, money market or bond fund. If the plan does not allow for this, you may be better off rolling over the funds to an IRA where you can select which investment to sell to fund a distribution.
Many 401(k) plans put restrictions on how frequently you can take withdrawals, or you may pay a fee if you exceed a certain number of withdrawals within a specific time frame. With an IRA you can set up monthly or even bi-weekly withdrawals to replicate your paycheck. Most retirees find the paycheck replication process is preferable to other distribution options, and some plans do not allow monthly direct deposit withdrawals from the plan.
When your employer changes the firm that administers the plan, the plan will go through a blackout period where you do not have access to your funds for a few weeks. Limited access can be problematic when you are retired. In addition, when this happens, you may have to redo paperwork to set up your bank deposit and beneficiary information. When you choose an IRA provider, it doesn’t change until you decide to change it.
While most 401(k) plans allow you to set up both federal and state tax withholding, there are still some plans that can’t accommodate state-level tax withholding. With IRAs, you can set up both federal and state-level tax withholding.
When you have accounts in multiple places, there is yet one more place where you must update things when you have an address, bank account, name or beneficiary changes. When accounts are consolidated at one institution it becomes far easier to handle these administrative items as well as keep track of paperwork.
At age 72, required minimum distributions begin. If you have an IRA and a 401(k) you must take an RMD from each. If your 401(k) and other retirement accounts are consolidated into one IRA, then there is only one account to take RMDs from. This eases the administrative requirements as you enter your 70s and beyond.
Many people choose to hire advisors to help manage things in anticipation of their own potential cognitive changes later in life or to provide continuity for a spouse who may not be the primary financial decision-maker. Once funds are rolled to an IRA, an advisor can provide full assistance as needed; their services are limited when funds remain in a 401(k) plan.
Many, but not all, 401(k) plans allow access to your funds through a 401(k) loan. You can’t take a 401(k) loan from a 401(k) plan when you no longer work for that employer. However, if you will be joining a new employer, you may be able to roll your old 401(k) into the new one, and then this loan option may be available to you. You cannot borrow from IRAs.
Creditor projection is also a factor to consider. Laws vary by state and while most states offer creditor protection for a portion of IRAs, generally assets inside employer plans have a greater level of protection. For retirees with business ventures or outside circumstances that put them at risk for litigation, this factor should be weighed more heavily.
Pricing: How Much Will You Pay For Your Plan?
If the expense ratios on the investments inside your 401(k) plan are average or below average when compared to similar quality funds with similar asset classes, that is a positive attribute for the plan. However, you can often find similar quality funds with the same or lower expenses outside of the plan.
You should also find out if there are administrative fees that you pay, or if your employer covers those. Many plans also offer managed account options for an additional fee. You pay for the managed account when you want a service that selects and rebalances the options for you. This service, however, will not coordinate the allocation with investments you may own outside the plan. Such investment services manage the account as its own separate unit.
You typically see higher fees in 401(k) plans that are administered by insurance companies such as Voya or John Hancock and lower fees when the plan provider is an investment company such as Vanguard, Fidelity or Charles Schwab.
If an advisor will be managing your IRA, you also need to consider the additional fees they will charge, which will typically result in a higher total fee than what you are paying within your 401(k) plan.
To evaluate the rollover decision, decide if the services the advisory firm offers, and other benefits of consolidation outlined in this document seem fair in comparison to the pricing.
About the author
Dana Anspach, CFP®, RMA®, is the founder of Sensible Money, LLC, a fee-only professional services firm that specializes in retirement income planning as well as the author of The Great Courses lecture series How to Plan for the Perfect Retirement (2021), Control Your Retirement Destiny 2nd Edition (2016), and Social Security Sense (2015).
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