On a weekly basis, we answer many personal finance questions, either for our clients or for radio listeners. The most common question asked is what to do with an existing 401(k) balance that was accrued when working for a former employer. General rules about rolling over 401(k) balances can help guide you through this process, but it is important to ensure that you carefully apply all of the pertinent rules to your personal situation. It is also important to consider the economic bias of those who work in the financial services industry. They may try to convince you that rolling over your 401(k) balance into an individual retirement account (IRA) is always the best choice, which may be true for the financial services industry, but it is not necessarily always the best choice for you.
The first step you should take when determining whether you should roll over your 401(k) balance into an IRA is to identify the types of 401(k) or 403(b) assets that you currently hold. The most common asset is the traditional pre-tax account balance, then the relatively new Roth IRA account balance, and last, an after-tax non-deductible balance. The second step is to identify whether you own the stock of your previous employer in your 401(k) account (this is never true of a 403(b) account).
If your 401(k) balance is a traditional pre-tax account asset, then it may be wise to roll over the balance from your former employer into your retirement account with your new employer for the following reasons:
- You may need to take out a loan against your 401(k) and want to keep open the option to do so.
- You intend to work past 70 years of age, which will allow for no required minimum distributions at age 70.5 years.
- You work in a profession that carries personal liability, or you are being sued/expect to be sued. Qualified plans under the Employee Retirement Income Security Act of 1974 usually have the greatest protection from lawsuits.
- You want to keep traditional IRA balances at $0 to allow for non-deductible contributions to be converted yearly to a Roth IRA.
- Your new employer has some unique investment options unavailable to your IRA.
The following are reasons not to roll your 401(k) balance into your new retirement account:
- You want the greatest control and flexibility over managing the funds.
- Your new employer plan is poorly designed and expensive.
- You want to keep your accounts consolidated.
- You have previous employer stock in your 401(k) and want to use a strategy of net unrealized appreciation. (Note: This is very technical and should only be performed under the guidance of a tax professional. The mechanics of this strategy are beyond the scope of this article. If you have company stock in an old 401(k), do not roll over any assets without talking to an impartial tax professional).
- It is a sum of money for which you are willing to pay taxes; thus, you roll over the balance to a Roth IRA and pay taxes on the pre-tax rolled-over amount.
There is only one good reason to roll over Roth IRA 401(k) amounts into a new employer retirement plan, which would be for liability-protection purposes. If you have Roth assets in a retirement account with a former employer, then you should only roll over the balances into a Roth IRA for the following reasons:
- Roth IRAs never have a required minimum distribution, but Roth 401(k) and Roth 403(b) amounts do at age 70.5 years.
- Roth IRAs allow for tax-free withdraw of contributions at any age; thus, it is critical to determine the balance amount being rolled over from a previous employer retirement plan. Company plans normally will not allow for distributions until you turn 59.5 years or leave the company.
- Roth IRAs allow for the greatest ability to focus on growth, and you can be as aggressive as you desire. The tax-free Roth account is the perfect environment for growth.
If you have after-tax non-deductible contributions in your retirement account (this is somewhat rare), then it would be wise to comply with the following guidance:
- Never roll over these funds to the new employer plan or to an IRA.
- Always roll these funds to a Roth IRA unless you absolutely need the cash. If this is the case, then take these after-tax contributions as a distribution.
- Any earnings on after-tax non-deductible contributions should be treated the same as the aforementioned pre-tax guidance.
Beware of economic bias in the financial services industry, which seems to continually believe that rolling over an existing 401(k) balance—accrued when formerly employed with another company—to an IRA account is always the best solution. By doing so, you may be making a monumental mistake by not obtaining unbiased comprehensive advice from a fiduciary-based personal financial professional.