At some point, almost everyone changes jobs – often leaving behind retirement plans such as 401(k)s. Conventional wisdom holds that you roll that old employer-sponsored plan into a new individual retirement account. But what kind of new IRA?
First, you can roll your former employer’s 401(k) into the plan from your new employer (within 30 days), which gets you continuing tax-deferred growth of your assets and deferred required minimum distributions, among other ongoing benefits. Not all employers accept rollovers from previous employers’ plan, though, and investment options of your new 401(k) may be more limited in number compared with an IRA.
If you do decide to roll into a new IRA, check:
Expenses. Generally, many employer-sponsored plans can offer investments (generally mutual funds) much cheaper than you as an individual can get in an IRA. Employers usually have a large number of workers and plan providers many clients in the same funds, leading to economies of scale.
Expense ratios, a measure of what it costs an investment company to operate your fund, therefore tend to be lower than in IRAs. Additionally, if you do roll over to an IRA, consider a fund company that doesn’t charge loads (commissions to a broker, financial advisor or similar professional who selects holdings for the fund).
Funds flexibility. Some employer-sponsored plans offer funds with more congenial terms than you get with an IRA.
For example, an index fund in a 401(k) may allow you to contribute only $50 per period, where the same index fund outside of the plan might require a minimum $10,000 contribution. Some employer plans may offer mutual funds of companies not available to the general public, as well.
Taxes. Rolling over from a 401(k) to a traditional IRA is usually a non-issue when consider taxes. Rolling over from a pre-tax contribution plan such a 401(k) to a Roth IRA, on the other hand, almost certainly brings tax implications.
Your pre-tax money usually becomes taxable when the rollover occurs. Your wisest move: Roll over the entire amount and pay the taxes from outside of the rollover amount.
If you want taxes withheld from the rollover amount, the Internal Revenue Service counts this withholding as a taxable distribution and, if you’re younger than 59½, tacks on a 10% early withdrawal penalty.
Control. Generally, moving to an IRA gives you more control of your money than you had with a 401(k). You may also enjoy access to a broader selection of funds than in your old 401(k) and may also contribute more money to the IRA even after you left your employer.
Net unrealized appreciation (NUA). When you own your employer’s stock in your 401(k), you can elect NUA tax treatment, meaning that you can treat the basis of the stock purchased as taxed as ordinary income and your holdings’ subsequent appreciation incurs long-term capital gains tax rates. You lose NUA treatment if you roll over into an IRA.
Ask questions, seek advice and talk to a competent financial planner about the details of your particular rollover.
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Sterling Raskie, CFP, is an independent, fee-only financial planner at Blankenship Financial Planning in New Berlin, Ill. He is an adjunct professor teaching courses in math, finance, insurance and investments. His blog is Getting Your Financial Ducks in a Row, where he writes regularly about investments, retirement savings and financial planning. His latest book is Lose Weight Save Money.
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