To Roll or Not to Roll?

At some point in almost everyone’s lifetime they have gone through the process of changing jobs. Many times those jobs offered retirement plans such as 401(k)s 403(b)s, etc. Conventional wisdom would say that for most employees it may make sense to roll their employer sponsored plan into an IRA. Based on a request from a reader (thanks David!), I thought I would go over some of the issues to consider before rolling your employer sponsored plan to an IRA.

1. Check expenses. Generally, many employer sponsored plans are able to offer their respective investments (generally mutual funds) for much cheaper than an individual could get in an IRA. The reason is that generally employers have a large number of employees and plan providers generally have many clients in the same funds. This leads to economies of scale where the funds don’t have to be expensive since there are so many people participating in them. Expense ratios therefore tend to be lower than in IRAs. Additionally, if you do roll over to an IRA, consider a fund/company that doesn’t charge loads (commissions).

2. Check the funds available. Some employer sponsored plans may have access to funds that might be more difficult to come by in an IRA. For example, an index fund offered in a 401(k) may allow only $50 per pay contribution whereas the same index fund outside of the plan would have a minimum of $10,000. Some plans may offer mutual funds of companies not available to the general public as well.

3. Check taxes. Rolling over from a 401(k) to a traditional IRA is usually a non-issue when consider taxes. However, if you’re rolling over from a pre-tax plan like a 401(k) to a Roth IRA there will almost certainly be tax implications. What generally will happen is that the pre-tax money will become taxable when the rollover occurs. It’s very wise at this point to roll over the entire amount and pay the taxes from outside of the rollover amount. Should you choose to have the taxes withheld from the rollover amount the IRS will count this withholding as a taxable distribution and if you’re under age 59 ½ they’ll tack on a 10% penalty.

4. Check control. Generally, a positive to moving to an IRA is that you now have more control of your money versus a 401(k). You may have access to a broader selection of funds than what was offered in the plan and you may also take advantage of contributing additional money to the IRA even after you’ve left your employer.

5. Check NUA. When there’s employer stock that the employee owns in their 401(k) they can elect net unrealized appreciation tax treatment. This means that an employee can treat the basis of the stock purchased as taxed as ordinary income, while subsequent appreciation is taxed at long-term capital gains. NUA treatment is lost if rolled to an IRA.

If you’re considering rolling over your employer sponsored plan to an IRA, it never hurts to ask questions, seek advice, and talk to a competent fiduciary financial planner. They may help you avoid unintended consequences while directing you to the best option for your needs. That’s how we roll (sorry, couldn’t resist).