8 Crucial Items You Need to Know Before Rolling Over Your 401(k) or Company Sponsored Retirement Plan

Wednesday, November 16, 2016 Joseph M. Prisco Jr., JD, CFP®

Your decisions when you retire or change employment status is crucial to optimizing your retirement plans.

We all look forward to the day when we can finally collect our hard-earned retirement savings, whether by voluntary retirement, inheritance, or otherwise. However, rushing the transition from accumulating to withdrawing funds from your company sponsored retirement plan could potentially be costly in terms of increased tax burdens. Planning for the next phases or your life should not be taken lightly.   

If your employer requires a distribution of your 401(k) or other employer sponsored plan funds when you leave employment, rolling it over to an IRA may be your only option provided by the plan for avoiding unnecessary taxes in the short-term. A lump sum distribution from the tax shelter taken directly to you outside of an IRA will likely bump you into a higher tax bracket, 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 to take distributions. In addition, if you have multiple retirement plan accounts at more than one past employer, 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 most personal financial questions is: “IT DEPENDS!” Everyone’s situation is different!

Be that as it may, below are 8 key factors for you to consider:

  1. Penalty-Free Withdrawals: If an employee leaves his or her employer between age 55 and 59½, he or she may be able to take penalty-free withdrawals from an employer plan. In contrast, penalty-free withdrawals generally may not be made from an IRA until age 59½.

  2. Borrowing and Loans: Many employer sponsored retirement plans allow for employees to take loans against their retirement assets, with limitations, while almost all IRAs do not allow for loans or collateralization.

  3. Protection from Creditors and Legal Judgments: Generally speaking, employer plan assets have protection from creditors under federal ERISA laws, while IRA assets 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. (More on this another time.)

  4. Required Minimum Distributions: Once an individual reaches age 70½, the rules for both employer plans and IRAs require the periodic withdrawal of certain minimum amounts, known as a required minimum distribution. If a person is still working at age 70½, however, he or she generally is not required to make required minimum distributions from his or her current employer’s plan, thus deferring the income taxes on those distributions for longer.

  5. Employer Stock: If you hold employer stock within your employer retirement plan, please proceed with extreme caution. 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 the basis (what you initially acquired the shares of stock for) which can significantly reduce your tax burden on the appreciated employer stock. I will plan to expand on this NUA topic (Net Unrealized Appreciation) another time.   

  6. Investment Options: An IRA usually enables an investor to have increased options and a broader range of investments types available as compared with an employer sponsored retirement plan. This can both help and hurt investors as sometimes too much choice can cause inaction. Conversely, more options can allow for more customization of your financial goals and objectives. Despite the ease and attraction of leaving your money in your employer plan, if the plan has limited or poor investment choices, you may want to opt for an IRA rollover.

  7. Services: Different levels of service are likely available under each option. Some employer retirement plans provide access to investment advice, planning tools, telephone help lines, online access, educational materials, and workshops. Similarly, IRA providers offer different levels of service, which may include more personalized and comprehensive investment advice, comprehensive financial planning and estate planning, among other items. An evaluation of the service provider should be made in the context of the value provided and costs to the investor.

  8. Fees and Expenses: It’s been said that there is “no such thing as free lunch.” 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 plan administrative fees (e.g., recordkeeping, compliance, trustee fees) and fees for services, 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.

As you may know, the considerations stated above are examples of some of the factors when analyzing your options. Other considerations also might apply to specific circumstances.

No matter which method you choose for taking distributions from your employer sponsored retirement plan, it is always wise to consult with an experienced and knowledgeable professional.

Joseph M. Prisco Jr, JD, CFP® is the founder of Advocacy Financial, LLC. He helps clients manage and optimize their financial and estate planning affairs. For more information, or to consult with Mr. Prisco, call 888-787-4590 or write to him at jprisco@advocacyfinancial.com