By JP Pedinielli

I’m not sure the Clash were talking about their retirement plans when they wrote the song “Should I stay or should I go” but it certainly would have fit the circumstances. Let’s look closer at the pros and cons of rolling over your defined contribution plan to an IRA when you change jobs.  When changing jobs, you have several choices to make with the funds in your retirement account whether it be a 401(k), 403(b) or similar plan. You can cash out your retirement account, leave the account where it is, transfer the account to your new employer’s plan, or roll it over to an IRA account.  For most people it makes no sense to cash out your account as taxes and potentially an early withdrawal penalty are too costly and not beneficial.

As with most financial planning related items things are not always as straight forward as it may seem.  It is always best to weigh the pros and cons and make the choice that fits your personal needs the best.

Pros for rolling over your 401k to an IRA account:
  • Investment choices: 401k plans often have limited investment choices which may include just a few mutual funds and maybe even company stock.  An IRA account allows you to broaden and diversify your retirement account with greater access to mutual funds, ETFs, and individual stocks and bonds.  
  • Cost and Fees: The mutual funds in your retirement plan may not be offering you the lowest fees.  Actively managed mutual funds have a higher internal expenses and often include plan administration fees and some even charge for marketing fees--  compared to passive investment alternatives.  These costs are passed onto you, the investor.   Outside of a 401k, the cost of purchasing individual equity positions and index ETFs may be commission free.  Some 401k accounts also charge annual account fees or trading costs while many online IRA accounts at brokerage firms like Charles Schwab carry no account fees.
  • Roth Conversion Flexibility:  If you plan on making Roth conversions, you are often unable to make a Roth conversion from your employer sponsored retirement plan.  Rolling over your funds into an IRA account allows for flexibility and opportunity to make Roth conversion and setup for tax-free withdrawals in the future.  
  • Net-Unrealized-Appreciation:  When you exit employer plans that contain company stock, you may have the opportunity to complete a tax favored withdrawal of employer stock.   There are strict rules associated with NUA transactions which include that shares must only be from company stock originally purchased in the employer sponsored plan and there must be a complete distribution of all funds from the employer sponsored plan to qualify for tax benefits. Your financial planner should be able to assist you to identify if this is a good strategy for you.
  • Required Minimum Distributions:  If you are at the age where you must make a RMD from your retirement accounts you can aggregate all your IRA account balances and take an RMD from only one IRA account.  You must take RMDs from each 401k account and you can not aggregate accounts if you have multiple 401k plans outstanding.  So you’ll have to contact each custodian every year to arrange withdrawals.  
  • Withdrawals:  Some 401k plans may offer only a lump sum withdrawal option.  However, if a partial withdrawal is allowed, you may be limited in selecting which investments to sell for your distribution.  Your funds could be equally distributed across your 401k account.
  • Simpler Rules: IRA accounts have fewer and simpler rules than 401k accounts.  For example, IRS rules dictate you must have at least 20% withholding withheld for taxes from a 401k distribution.  IRA distributions do not  have that requirement, although you can elect to withhold any amount you would like.  
  • Beneficiary:  IRA accounts allow you to choose and change your beneficiary designation.  Employer sponsored plans generally must name your spouse as beneficiary absent a signed waiver from your spouse.
  • Payouts:  Payouts and distributions are often subject to the rules of the individual 401k plan that can include withdrawal restrictions.  IRA accounts offer more flexibility in making distributions that can be help facilitate estate planning.  

Cons for rolling over 401k plan to an IRA account:

  • Trustee to Trustee transfer:  There are tax and penalty consequences for electing to make a 401k rollover to an IRA, but instead you take possession of the funds and forget to deposit the funds into an IRA account within 60 days.  The safest way to make the transfer is through a “direct” trustee to trustee transfer.
  • Stable Value Fund:  Some plans may offer a fixed income alternative called a Stable Value Find.  This pays a fixed interest rate and the value of the investment does not fluctuate.  Some risk-adverse investors may prefer this option.
  • Early Withdrawal:  There is an IRS rule that allows employees who leave their jobs in the calendar year they turn 55 or later that allows penalty-free withdrawals from that employer’s 401(k) plan, rather than waiting until 59 ½ in an IRA. Taxes will still be due on the withdrawals and numerous limitations apply.
  • No-RMDs:  If you have reached the normal age where RMDs start, if you are still working, you may be able defer RMD’s until you retire.  
  • Roth Contributions:  If you do not have any funds in an IRA account, it may be easier to make a non-deductible IRA contribution and qualify for a backdoor Roth conversion.  With proper planning, this issue can be mitigated.
  • Lawsuits:  Your 401k plan is generally protected from lawsuits.  Federal Employment Retirement Income Security Act (ERISA) shields 401(k) and other types of employer-sponsored retirement plans from creditors.  IRAs generally don’t offer the same level of creditor protection so for accounts that exceed $1.0 mil., consider contacting an asset protection attorney for guidance.
  
These are just some of the more common points to consider when rolling over your employer plan. However, with sound guidance from your tax and investment advisory team, you can make a decision on your retirement account that will best fulfill your personal investment objectives.