Things to Consider Before Rolling Over Your Old 401k

Remaining at one company for an entire career is unheard of in today’s work culture. According to the Bureau of Labor Statistics, most Americans will have held close to a dozen jobs by the their mid-40s. Along with a collection of old badges and business cards, that trend means most workers will have more than one old 401(k) to sort out as they approach retirement age. Before automatically rolling them over into an IRA, it’s important to examine your situation and weigh the options.

The Positives

401(k)s typically have a limited number of mutual funds to choose from. By rolling your 401(k) over to an IRA, you can choose from virtually the entire universe of funds or buy individual stocks, bonds, options, preferred stocks and so forth. Having more choices at your disposal is certainly a positive.

Rolling over old 401(k)s also simplifies the investment process. You can remove the complexity of generating allocations, placing transactions and tracking performance across multiple accounts and plan sponsors. Your retirement saving will be conveniently located in one account were it is much easier to manage.

Rolling over your 401(k) also gives you the ability to do a Roth conversion. When you convert your Rollover IRA to a Roth IRA, you pay the tax on the amount you are converting but will never pay taxes again on that money. Furthermore, you won’t be forced to take required minimum distributions when you turn 70.5 years old.

The Drawbacks

The main drawback occurs if you retire prior to age 59.5. A retiree can begin taking distributions from a 401(k) at the age of 55 and avoid paying a 10% IRS penalty. By rolling over to an IRA, you are giving up that option in favor of the advantages discussed above.

Additionally, rollover IRAs do not allow for loans. If there is a need for money, you will have to take a distribution and pay the tax. Money left in a 401(k), on the other hand, can be borrowed against. The IRS allows a loan up to the lesser of $50,000 or 50% of the 401(k) balance. This might come in handy if an emergency pops up and there is a need for a significant amount of cash. The loan is not taxed as long as it is paid back over a period of five years. Furthermore, the interest on the loan is paid back to your account and not a bank.

There is another situation in which a retiree should think twice about a rollover. It involves company stock purchased within a 401(k) plan. Typically, the basis for the stock will be pretty low. Rather than rolling the position over into an IRA, a person can elect to pull the stock position out of the 401(k) and pay tax up to the amount of the basis. After a sale of the stock, that person would pay long-term capital gains on the difference of sale price and cost basis. This generates a tax savings since long-term capital gains rates are typically lower than one’s income tax rate. This strategy is referred to as Net Unrealized Appreciation (NUA).

With all of the variables in play, it’s important for you to talk to your advisor before rolling over your old 401(k)s. One wrong move and you could and up forfeiting a chunk of your retirement savings to Uncle Sam.

Matt Markowski is a Certifified Financial Planner™ of the national financial planning firm Markowski Investments.