NEW YORK (MainStreet) — You work hard and build up a nice, fat 401(k). Then, as you get set for retirement, you roll it over to an IRA. That's the way it's done. But what if investors have been doing it wrong all along? What if you should roll your IRA into your 401(k)? It's called a reverse rollover. And it's a strategy most financial advisors are not familiar with, according to Michael A. Martin, a financial advisor with Legacy Financial Partners in West Palm Beach, Fla.
"One of the most beneficial things about a 401(k) versus an IRA is that if you are still working and over 70.5, you won't need to begin your Required Minimum Distributions if you don't need the income," Martin says. "For executives and high-income earners, this is a real benefit, as many of them don't want to start drawing from these types of accounts and want to continue to defer the tax. With many people still working at this age — or coming out of retirement to work — it makes a lot of sense."
Martin says many of the people who can benefit from such a strategy are often small-business owners, but there may be a hitch.
"Unfortunately this little-known tax-deferral strategy doesn't apply to them if they have more than 5% ownership in the sponsoring company," Martin adds.
But for the rest of us, a reverse rollover may offer some other benefits as well.
"If you leave your employer in or after the year you turn 55, you can take withdrawals from your 401(k) prior to age 59.5 without the 10% early withdrawal penalty," says Ed Snyder, a certified financial planner in Carmel, Ind. "If you are in a situation where you are retiring early, have a large IRA from a previous rollover and will need income from your investments, it makes sense to move the IRA to the 401(k) so that you can take penalty-free withdrawals."
Steven Brett, an independent financial advisor in Melville, N.Y., bullet points some additional reasons a reverse rollover might make sense:
- It promotes ease of record-keeping and the convenience offered by a consolidation of accounts.
- A reverse rollover potentially increases the amount you can take as a loan in a retirement plan — if the plan allows for loans.
- The 401(k) plan may offer access to lower expense ratio mutual fund share classes.
Another benefit may be creditor protection. Qualified retirement plans, such as 401(k)s, are federally protected from seizure by creditors, even if you file for bankruptcy. IRAs can have creditor protection as well, but such laws vary from state to state.
Of course, no investment strategy is perfect, and the IRA-to-401(k) rollover does have some possible drawbacks. Advisors often tout the wider investment choices available in an IRA — and the fact is, not all 401(k) plans allow IRAs to be transferred in. But, all in all, it may be a good idea to consider a little reverse engineering for your retirement savings strategy.