Not So Fast! 9 Special Considerations Before Rolling Over Your 401(k)

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Conventional wisdom has long told us that when you leave employment – either by taking another job, getting laid off, or retiring – it makes good sense to rollover your 401k plan to either an IRA or to your new employer’s 401k plan if that makes sense.

However – and if you read here much, you know there’s always a however in life – this decision isn’t as cut-and-dried as conventional wisdom leads us to believe.  As with just about every financial decision we make, it’s not wise to go off willy-nilly without considering all of the benefits that we’re giving up. (and if you’ve read much of my writings, you know I don’t cater much to the willy-nilly!)

9 Special Considerations Before You Rollover Your 401k

1. If you are happy with your former employer’s plan, consider it well-managed, with low cost, and possibly with some investment options that are not readily available (such as desirable mutual funds that are closed to new investors), you may want to leave the plan right where it is. This is especially beneficial if you don’t have another employer plan to rollover your 401k into, or if you are squeamish about setting up an IRA.
2. It is possible that maintaining a 401k account could garner you some employer-sponsored financial advice. Not all plans offer this, but if yours does, it could be a valuable option to keep. If you rollover your 401k, this benefit would be gone.
3. If you have commingled deductible and non-deducted IRA contributions in your IRA account, having an active 401k plan can help you to separate the deductible IRA money from the non-deducted.  See this article about the pro-rata rule for more information. Essentially this benefit gives you a way to bypass the “little bit pregnant” rule which requires you to aggregate all IRA funds pro-rata when making distributions. This is a common issue when doing a Roth IRA conversion, for example. If you rollover your 401k, this option may be lost, unless you rollover into a new 401k.
4. If you have an investment in your former employer’s stock in your 401k, you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover. This article explains NUA, in case you need a refresher. The point is, if you’ve taken even a partial rollover of your 401k in a previous year, the NUA treatment is no longer available to you.
5. If you think you may be returning to this employer, it might make sense to leave your funds where they are. This is especially true for government employers with section 457 plans – due to the nature of these plans’ ability to provide you with retirement income without penalty much earlier than an IRA or 401k can.  With the vagaries of governmental policy changes, if you’ve withdrawn and closed your account and come back to work for the same agency, the old plan may no longer be available to you since you’re a “new” participant.
6. If you’re at or older than age 55 and are not moving to a new employer (or are undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty.  If you rollover your 401k to an IRA or to a new employer’s 401k plan, this option is lost.
7. On the off-chance that you might need a loan from your retirement funds, you should know that IRAs do not have this provision.  Retain at least some balance in the plan if you might need this option – but also you should check with your plan administrator to see if this option is available for non-employee plan participants, because it might not be (and actually, it likely is not).  But keeping in mind #5, if you’ve maintained a healthy balance in the plan and you return to work with this same employer, you’d have a much larger account to work with if you needed to borrow.
8. Funds in a 401k account are protected by ERISA – and as such are generally not available to creditors in the event of a personal bankruptcy.  Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy.  If you’d like to bone up more on this, see this article.  At any rate, ERISA protection is pretty much an absolute, so this is yet another reason you might consider leaving funds in a former employer’s 401k plan.
9. Take your after-tax contributions out first, if your plan happens to include these.  If you’ve made after-tax contributions, as some plans allow, it makes sense to separate these contributions from the pre-taxed amounts.  You can then convert this after-tax money directly over to a Roth IRA in most cases without tax. This is because the 401k isn’t subject to the “little bit pregnant” rule alluded to earlier.  Once you’ve removed the after-tax contributions and put them into a Roth IRA, you might want to rollover your 401k (the remaining money) if it makes sense.

I don’t imagine that this is an exhaustive list of all the reasons you need to stop and think about it before rolling over a 401k plan, but we’ve hit the high points.  If you have other good reasons to share, please leave a comment!