White Paper: The Benefits and Value of an In-Service Rollover from Your Employer 401(k) Plan

Introduction

When employees change jobs or approach retirement, they typically face a decision regarding their employer-sponsored 401(k) plan: Should they leave the money in the employer plan, cash it out, roll it over to their new employer’s plan or roll it over into an individual retirement account (IRA)? However, many employees are unaware that they may have the option to perform an in-service rollover while still employed with the company. An in-service rollover allows individuals to transfer a portion or all their 401(k) assets to an IRA without leaving their employer or formally retiring. This white paper explores the ??in-service rollover strategy, providing insights into how employees can enhance their retirement planning and investment flexibility while still participating in their employer’s 401(k) plan.

What Is an In-Service Rollover?

An in-service rollover occurs when an employee rolls over assets from their employer's 401(k) plan to an IRA while still actively employed by the company. Not all employers offer this option, and the rules governing in-service rollovers can vary depending on the plan administrator. However, many 401(k) plans allow employees to move a portion or all of their vested funds into a traditional IRA or Roth IRA.

Types of In-Service Rollovers

1. Traditional 401(k) to Traditional IRA: This is the most common form of rollover and maintains the tax-deferred status of the funds.
2. Traditional 401(k) to Roth IRA: This rollover converts pre-tax assets into after-tax assets, triggering taxes on the rollover amount but providing tax-free growth moving forward.
3. Partial Rollover: Employees may opt to roll over part of their 401(k) balance, leaving the remainder in the employer plan.

Key Benefits of an In-Service Rollover

1. Greater Investment Flexibility

Employer-sponsored 401(k) plans often have a limited selection of investment options, which may not provide the level of diversification or specific investment choices that an employee desires. An in-service rollover to an IRA provides access to a wider range of investment vehicles

2. Potential for Lower Fees

401(k) plans often charge administrative fees, fund management fees, and other costs that can reduce long-term growth. By rolling over funds into an IRA, employees can potentially reduce fees, especially if they select low-cost index funds or exchange-traded funds (ETFs) within the IRA. IRAs, particularly self-directed IRAs, allow for greater transparency regarding the costs associated with different investment options.

3. Consolidation of Retirement Accounts

An in-service rollover allows individuals to consolidate multiple retirement accounts, making it easier to track performance, rebalance, and manage their retirement savings. Instead of keeping track of numerous 401(k) plans from various employers, rolling over funds into a single IRA can simplify account management, reduce paperwork, and streamline the retirement planning process.

4. More Control Over Your Retirement Savings

Rolling over assets to an IRA provides the account holder with more control over how the funds are managed. Unlike a 401(k) plan, which is typically managed by a plan administrator or financial institution, an IRA can be directly managed by the account holder or a trusted financial professional. This greater level of control may appeal to those who are more investment-savvy or who want to take a hands-on approach to their retirement savings.

5. Avoidance of Required Minimum Distributions (RMDs)

While 401(k) plans are subject to Required Minimum Distributions (RMDs) starting at age 73 (as of 2024), IRAs offer more flexibility. If an employee is still working for the employer sponsoring the 401(k), they can delay RMDs on the 401(k) funds until they retire. However, rolling over the funds into an IRA can allow the account holder to delay RMDs beyond age 73, as long as they continue to work and do not withdraw from the IRA.

6. Roth Conversion Potential

An in-service rollover can provide an opportunity to convert pre-tax assets into a Roth IRA, which offers significant tax advantages. While this move triggers income taxes on the converted amount, the funds grow tax-free going forward and distributions in retirement are also tax-free, provided the account has been open for at least five years. A Roth IRA may be an attractive option for those expecting to be in a higher tax bracket during retirement.

7. Protection from Creditors

In some cases, assets in an employer-sponsored 401(k) plan may be subject to creditor claims if the employee faces legal or financial troubles. However, funds rolled over into an IRA may not be as well-protected under federal law, depending on the state in which the employee resides. It is important to consult with a financial or legal professional regarding creditor protection based on individual circumstances.

8. Avoiding Loan Pitfalls

Some 401(k) plans allow participants to take out loans against their balances. However, if an employee takes a loan from their 401(k) and then leaves the company or retires, they may be required to repay the loan in full immediately. If they fail to do so, the outstanding loan balance will be treated as a taxable distribution, potentially incurring penalties. By rolling over funds to an IRA, employees avoid the possibility of having to repay loans if they separate from the company.

Considerations and Potential Drawbacks

While an in-service rollover can offer several advantages, there are also important factors to consider:

1. Eligibility and Plan Restrictions

Not all 401(k) plans allow in-service rollovers, and some plans may impose restrictions, such as minimum age or vesting requirements. It is crucial to review the specific terms of the employer’s 401(k) plan and consult with the plan administrator to understand the rollover rules.

2. Potential Loss of 401(k) Plan Features

Certain 401(k) plans may offer unique benefits that an IRA cannot replicate, such as:

• Employer matching contributions (if applicable)
• Access to institutional-quality investment options
• Loan provisions
• Hardship withdrawal provisions

3. Tax Implications of a Roth IRA Conversion

If an employee rolls over funds from a traditional 401(k) into a Roth IRA, they will owe taxes on the amount converted. This may result in a significant tax bill for the year in which the conversion occurs. It is important to evaluate the long-term tax implications before making a decision.

4. Withdrawal Rules and Penalties

Funds in an IRA may have different withdrawal rules than those in a 401(k) plan. For example, early withdrawals from an IRA are subject to a 10% penalty before age 59? unless specific conditions are met (e.g., first-time home purchase, qualified education expenses). However, 401(k) plans may offer more flexibility in certain withdrawal scenarios, such as loans or hardship distributions.

Conclusion

An in-service rollover offers a unique opportunity for employees to gain greater control over their retirement savings, diversify investments, and reduce fees while still employed. It is a powerful tool for those looking to optimize their retirement strategy by expanding investment options, potentially lowering costs, and gaining more flexibility with account management. However, employees should carefully evaluate their 401(k) plan's provisions, the potential tax implications, and the long-term benefits before proceeding with an in-service rollover. Consulting with a financial services professional is highly recommended to ensure that this strategy aligns with the individual’s retirement goals and financial circumstances.

By understanding the benefits and value of an in-service rollover, employees can make more informed decisions and take proactive steps toward a more secure and flexible retirement.

This white paper is for informational purposes only and is not a recommendation to buy or sell any asset or investment.

Neither New York Life Insurance Company, nor its agents, provides tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.

Roger Silvera is an Agent with New York Life Insurance Company (CA insurance lic. #:0E64535) and a Registered Representative offering securities through NYLIFE Securities LLC (Member FINRA/SIPC), a Licensed Insurance Agency and New York Life company, 3000 Bayport Dr., Suite 1100, Tampa, FL 33607

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