Should you Rollover your 401(k)?

By: Curtis Hill, CFP, and Irina Hill, CPA, MBA and Registered Investment Advisor

When you leave your job, you can either leave your company’s retirement plan behind, move it to your new employer’s plan, or roll it over to your IRA. Done correctly, none of these choices would cause any current tax consequence. Another option is to simply withdraw the value and pay taxes. But which of these options is the best? Three issues may govern your decision.

1. Investment Issues.
2. Tax Liability in Retirement.
3. Technical Issues.

Investment Issues:

The investment choices in both your previous 401(k) and in your new employer’s plan are likely highly limited, based on traditional investment models, and often vary between mediocre to just poor choices. Most investment choices are simple index followers, which are subject to all the volatility of the stock or bond markets. Huge losses like we experience in the first quarter of 2020 and the first three quarters of 2022 are common with these traditional mutual fund investments.

Often the mutual funds allowed in your 401(k) choices have been selected for reasons other than their merit. The absolute worst of these investment options are the highly promoted target date funds. The concept of determining your bond versus stock allocation based on simply your age is a ridiculous over simplification. This decision should be based on current interest rates, the direction of future interest rate changes, and current stock market valuations. ?Your retirement date should not be the only consideration regarding your investment allocation!!!

Institutions, university endowment funds, and sophisticated investors will typically allocate considerable amounts to alternative investments. However, most 401(k) plans allow for zero allocation to alternatives. Why are 401(k) plans so limited?

Often, it’s better to rollover your 401(k) to an IRA where you have better control and YOU select the investment options.

Tax Liability in Retirement:

We have been brain washed about the advantages of tax-deferral which have been pushed excessively by the financial industry. Thus, many of us are overly concentrated in IRA and 401(k) tax-deferred accounts that leave us highly exposed to taxes in retirement. Our book “The Wealth Conspiracy: Avoid the Dark Side of Wall Street” points out negative issues regarding tax-deferral. Chief among them is the dangerous tax liability you are building up for your retirement years. The extreme likelihood of higher tax rates in the next 20 to 30 years may more than neutralize any benefit gained from tax-free compounding.

You should evaluate how much concentration you have in tax-deferred accounts and instead consider investments that have zero taxes in retirement.

Technical Issues:

Other issues involve protection from lawsuits, and delaying required minimum distributions (RMDs).??

Protection against lawsuits?

Company plans are mostly ERISA plans, and IRAs are not. ERISA plans (Employee Retirement Income Security Act) are protected by federal law from creditors, while IRAs are typically not. So, if you are concerned about lawsuits, keeping your retirement funds in a 401(k) could be a better choice.??

Delaying RMD?

RMD distributions from retirement accounts are required once you reach age 72. However, there is a “still working” exception which applies to 401(k) that allows you to delay taking RMDs while still working. IRAs do not have this exception. So, if still working past age 72, not rolling over your 401(k) to an IRA may be your best option.

Tax consequences?

There are two tax-free ways to rollover your 401(k) to an IRA: Direct and Indirect.

A direct rollover is a trustee-to-trustee transaction whereby your 401(k) funds are sent directly by your 401(k) to your IRA custodian. Or the rollover check may be mailed to you, but the payee would be your IRA custodian for the benefit of your IRA account.

An indirect rollover is when you personally take a distribution from your company retirement plan and then subsequently deposit money into your IRA account. There are four drawbacks with an indirect rollover:?

1. There is a 20% mandatory federal income tax withholding with an indirect rollover. So, you only get 80% of your original 401(k) balance available for the indirect deposit into your IRA.

2. Then you must deposit the withdrawn funds into your IRA account within 60 calendar days in order to avoid income taxes.

3. You can only do one indirect rollover per calendar year.

4. You must find another source of funds to make up the 20% withholding, deposit that in your IRA, or that 20% would be taxed as a withdrawal.

Conclusion

The question of what to do with your retirement plan when you change jobs is complex. Maybe it would be best to discuss the situation (at no cost) with a Certified Financial Planner, CPA, MBA, and realtor team who could better explain your options. Why not email us or schedule a call HERE

What do you have to lose? Maybe you will find out something worth knowing????