Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k)

1 November 2009 3 Comments Print This Post Email This Post

Conventional wisdom has long told us that when we leave employment – either by taking another job, getting laid off, or retiring – it makes good sense to rollover our 401(k) plans to either an IRA or to our new employer’s 401(k) plan if that makes sense.

However – and if you read here much, you know there’s always a however in life – this decision isn’t as cut-and-dried as conventional wisdom leads us to believe.  As with just about every financial decision we make, it’s not wise to go off willy-nilly without considering all of the benefits that we’re giving up. (If you’ve worked with me in the past, you know I don’t cater much to the willy-nilly…)

9 Special Considerations Before Rolling Over Your 401(k)

  1. If you are happy with your former employer’s plan, consider it well-managed, low cost, and possibly with some investment options that are not readily available (such as desirable mutual funds that are closed to new investors), you may want to leave the plan intact.  This would be especially beneficial if you don’t have another employer plan to roll over into, or you are squeamish about establishing your own IRA.
  2. Depending upon your opinion of future legislation being considered, it is possible that maintaining a 401(k) account could garner you some employer-sponsored financial advice.  There have been quite a few options floated in Congress regarding the requirement for employers to provide advice for their retirement plan participants, although none have been passed into law as of this writing.  Removal of your funds via a rollover would eliminate this benefit for you.
  3. If you have commingled deductible and non-deducted IRA contributions in your IRA account, having an active 401(k) plan can help you to “separate” the deductible IRA assets from the non-deducted.  See this article for more information.  Essentially this benefit gives you a way to bypass the “little bit pregnant” rule wherein you must consider all IRA funds pro-rata when making distributions… a common issue when doing a Roth IRA conversion, for example.  If you have no 401(k) plan, this option is lost.
  4. If you have an investment in your former employer’s stock in your 401(k), you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover.  This article explains NUA, in case you need a refresher.  The point is, if you’ve taken even a partial rollover of your 401(k), the NUA treatment is no longer available to you.
  5. If you think you may be returning to this employer, it might make sense to leave your funds where they are.  This is especially true for government employers with section 457 plans – due to the nature of these plans’ ability to provide you with retirement income without penalty much earlier than an IRA can.  With the vagaries of governmental policy changes, if you’ve withdrawn and closed your account and come back to work for the same agency, the old plan may no longer be available to you since you’re a “new” participant.
  6. If you’re at or above age 55 and are not moving to a new employer (or are undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty.  If you move these funds over to an IRA, this option is lost.
  7. On the off-chance that you might need a loan from your retirement funds, you should know that IRAs do not have this provision.  Retain at least some balance in the plan if you might need this option – but also you should check with your plan administrator to see if this option is available for non-employee plan participants, because it might not be (and actually, it likely is not).  But keeping in mind #5, if you’ve maintained a healthy balance in the plan and you return to work with this same employer, you’d have a much larger account to work with if you needed to borrow.
  8. Funds in a 401(k) account are protected by ERISA – and as such are generally not available to creditors.  Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy.  If you’d like to bone up more on this, see this article.  At any rate, ERISA protection is pretty much an absolute, so this is yet another reason you might consider leaving funds in a former employer’s 401(k) plan.
  9. Take your after-tax contributions out first, if your plan happens to include these.  If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.  You can convert these contributions directly over to a Roth IRA in most cases, income allowing (and in 2010, income won’t be a problem, either).  This is because the 401(k) isn’t subject to the “little bit pregnant” rule alluded to earlier.  Once you’ve removed the after-tax contributions and put them into a Roth IRA, you can then rollover the rest of your 401(k) if it makes sense.

I don’t imagine that this is an exhaustive list of all the reasons you need to stop and think about it before rolling over a 401(k) plan, but we’ve hit the high points.  If you have other good reasons to share, please leave a comment!

  • Keith

    dussisced the IRA Charitable Contribution option for folks age 70½ or better, and it’s possible from that article that you got the impression that if you are

  • http://www.bfponline.com/ Jim Blankenship, CFP®, EA

    Hello, Pamela -

    Yes, there is a way to remove the cream from the coffee, but as far as I know there’s only one way. That is to take all of the pre-tax contributions from your IRAs and move them into an active 401(k) or other qualified retirement plan (QRP) that accepts rollovers from IRAs. QRPs are the only vehicles that you can move these funds to – another IRA would not resolve anything.

    The reason that this works to separate the cream from the coffee is because 401(k) plans (and other QRPs) are ONLY allowed to accept rollovers of pre-tax money, which effectively presents the ability to transfer everything EXCEPT the after-tax contributions.

    If you’re trying to eliminate tax on the Roth conversion altogether, you’ll need to move all pre-tax amounts from all IRAs to the QRP.

    Otherwise, you could move portions of the pre-tax amount in order to increase the overall percentage of post-tax contributions that would be converted. However, I don’t know why you would only move a portion of the pre-tax amount and not all of it, since there’s not a limit on the amount of a rollover, thus no cost associated with the move (other than possible transaction costs). I suppose if the QRP was an undesirable plan (high expense ratios, poor choices, etc.), then you might not necessarily want to tie up a huge portion of your retirement funds there – especially if you intend to continue working there for quite a while.

    I hope this helps!

    jb

  • Pamela

    Jim,

    Regarding the “cream in the coffee rule” mentioned in the article link in item #3, I am wondering if there is any way that I can indeed take out just some of the coffee from my commingled IRA account.

    Here is my situation. I have a Fidelity IRA account that currently houses:

    * Several previous employer 401K plans rollovers (done in years 1994, 2001, 2006)

    *Deductible IRA contributions from years 1987-1990

    *Non-deductible IRA contributions from years 1991-2009

    In preparation for a ROTH IRA conversion, is it possible to move the 401K rollovers OUT of this IRA and into some other vehicle? Obviously I am interested in doing this in order to reduce the effect of the pro-rate calculation.

    Regards.