8 Things to Consider Before Rolling Over Your 401(k)

K’nex (Photo credit: -Snugg-)

Employers have been giving us lots of opportunities to make this decision of late: when leaving an employer, whether voluntarily or otherwise, we have the opportunity to rollover the qualified retirement plan (QRP) such as a 401(k) from the former employer to either an IRA or a new employer’s QRP.

This decision shouldn’t be taken lightly – although often it is the best option for you.  Moving to an IRA gives you much more control over your destiny, so to speak, by allowing you to choose from the entire universe of allowable investment choices.  Using your new employer’s QRP can give you a better sense of control over the account as well, although the flexibility of an IRA is generally preferable to another QRP.

But sometimes it makes the most sense to leave your money in the old plan.  Listed below are eight possible reasons that you might want to do just that.

1. If you are happy with your former employer’s plan, consider it well-managed, 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 intact.  This would be especially beneficial if you don’t have another employer plan to roll over into, or you are squeamish about establishing your own IRA.
2. If you have commingled deductible and non-deducted IRA contributions in your outside IRA accounts, having an active 401(k) plan can help you to “separate” the deductible IRA assets from the non-deducted.  See this article for more information.  Essentially this benefit gives you a way to bypass the “little bit pregnant” rule wherein the IRS treats all IRA funds pro-rata taxable and non-taxable when making distributions… a common issue when doing a Roth IRA conversion, for example.  If you don’t have an active 401(k) plan available, this option is lost.
3. If you have an investment in your former employer’s stock in your 401(k), you need to consider the ramifications of utilizing the Net Unrealized Appreciation (NUA) option – before doing a rollover.  The point is, if you’ve taken even a partial rollover of your 401(k) in a prior year, the NUA treatment is no longer available to you.
4. 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 a 401(k) plan could.  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.
5. If you’re in the year when you’ll reach age 55 or older, and are not moving to a new employer (either retiring or undertaking self-employment), maintaining the 401(k) plan gives you an option to begin taking distributions prior to age 59½ without penalty.  If you move these funds over to an IRA, this option is lost.
6. 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 #4, 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.
7. Funds in a 401(k) account are protected by ERISA – and as such are generally not available to creditors.  Depending upon the state you live in, IRA assets may be available to your creditors in the event of a bankruptcy.  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 401(k) plan. Funds moved from an ERISA-protected account can carry the protection on, but new contributions to the account do not.
8. 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 convert these contributions directly over to a Roth IRA in most cases.  This is because the 401(k) 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 can then rollover the rest of your 401(k) if it makes sense.