In the old days, before the Labor Department’s new conflict-of-interest rule became a reality, advisers almost always recommended rolling your 401(k) into an IRA when you left your employer.
The reason? Advisers earned money — in the form of commissions and/or fees — when you rolled your former employer’s retirement plan into an IRA, and they didn’t earn any money when you didn’t.
But starting next year, advisers will no longer be able to give a knee-jerk answer to the "should you leave your 401(k) with your former employer or roll it over to an IRA" question.
Instead, advisers will have to act in your best interest, as a fiduciary. They will have to analyze your options and their pros and cons and then suggest a course of action that’s right for you. What to consider?
Four options, not one. Know this from the start: Rolling your 401(k) into an IRA isn't your only option, nor is it always your best choice. “The truly smart move for you depends on your own individual circumstances and your fact-finding,” says Wayne Bogosian, president of PFE Advisors.
Generally, you can leave your 401(k) with your former employer; transfer it to your new employer’s plan; roll it into a traditional or Roth IRA; or take a lump-sum distribution.
Do you need creditor protection? Plans covered by the Employee Retirement Income Security Act of 1974 (ERISA), such as a 401(k)s, have federal protection from creditors. Your IRA, which is not an ERISA plan, is protected if you file for bankruptcy. But whether your IRA is protected from creditors in other types of proceedings depends on state law. If you need federal protection, consider leaving your 401(k) with your former employer or transferring it to your new employer’s plan.
Do you need the money before age 59½? Sheryl Garrett, founder of Garrett Planning Network, advises against rolling over the money in your 401(k) into an IRA if there’s any chance that you would need to, can afford to, or would benefit from taking money out of your qualified retirement plans before age 59½. You have to pay a 10% penalty tax when withdrawing money from your IRA before then; that’s not the case if you withdraw money from a 401(k) plan after age 55.
How much does it cost? Generally, leaving your 401(k) with your former employer or transferring it to your new employer, if that’s an option, will cost you less in fees and expenses than if you roll the account into an IRA, according to Garrett. However, the investment choices in an IRA aren't always more expensive than a 401(k) plan. You can, for instance, invest in low-cost index funds and ETFs. Ultimately, however, comparing the fees and expenses associated with a 401(k) vs. an IRA as well as the investments in those plans is difficult and time-consuming, according to Garrett, but it's the only way to learn which option is your best bet.
Investment options. Generally, unless you have and use the self-directed brokerage option, you’ll have fewer investments from which to choose in a 401(k) vs. an IRA. On average, there are 25 investment options in a 401(k) vs. thousands in an IRA.
Advice or not. If you need or want advice, you’ve got options. But it will cost you. You could use the investment advisory services and/or managed accounts services in your 401(k) plan. Or, you could roll your 401(k) into an IRA and pay an adviser a fee for assets under management and/or commissions to buy and sell investments and insurance products. Of course, you’ll need to compare the cost of these options and determine which is best for you.
Two warnings:
- “If a planner or adviser is telling you that the only way they can provide you with advice is if you roll over your money to their preferred IRA, get a new planner/adviser,” Bogosian says.
- Advisers to your 401(k) plan who recommend an IRA rollover may be providing conflicted advice, and that conflict is prohibited unless there’s an exemption.
Take a lump-sum distribution. The one thing you ought not do: “Taking a lump-sum taxable distribution is never a good option,” Bogosian says.
Other factors to consider:
- All or nothing. “Many plans have all-or-nothing rules,” Bogosian says. “All your money must stay in or leave the plan. So make sure you are confident with your decision.”
- Are you invested in company stock? If you roll over your 401(k) account balance, you will lose the tax benefits of employer stock. Consider instead distributing your employer’s stock into a taxable account. You’ll pay ordinary income tax on the stock’s cost basis, not the market value. And when you sell those shares, you’ll pay a long-term capital gains tax on what’s called the net unrealized appreciation or NUA.
- Outstanding loan? Generally, if you have an outstanding loan from your 401(k), it will come due within 90 days of you terminating employment. If that’s the case, ask your employer if “post-employment loan repayments are an option,” says Bogosian.
Bottom line. "Do your homework," says Bogosian. "This is one area where generalizing can cost you big money.”
Robert Powell is editor of Retirement Weekly, contributes regularly to USA TODAY, The Wall Street Journal and MarketWatch. Got questions about money? Email Bob at rpowell@allthingsretirement.com.
