When you shouldn't roll your 401(k) balance over to an IRA
Many people roll their 401(k) balance over to an individual retirement account each time they change jobs. Transferring your 401(k) balance to an IRA is usually a good financial move, especially if the IRA has better investment options and lower fees. Plus, it simplifies your financial life if you have fewer accounts to keep track of, and you might qualify for lower fees if you keep a large balance with a single financial institution. But there are a few specific cases when it's better to leave your retirement savings in a former employer's 401(k) plan.
You are between ages 55 and 59. There's typically a 10 percent penalty if you withdraw money from a 401(k) or IRA before age 59 ½. However, if you lose or leave your job at age 55 or later (or age 50 or later for public safety employees), you can take withdrawals from the 401(k) plan associated with the job you most recently left without having to pay the 10 percent early withdrawal penalty. If you roll your 401(k) plan balance over to an IRA upon leaving the job, you will have to wait until age 59 ½ to take penalty-free IRA distributions. "As long as the money stays inside of the company plan, you can have access to it without the 10 percent early withdrawal penalty if you were at least age 55 when you left your job," says Mike Sheehy, a certified financial planner and president of Client First Investment Management in West Bend, Wisconsin. "If you were to roll that over to an IRA, then you are back under the 10 percent early withdrawal penalty."
You plan to work past age 70 ½. Annual withdrawals from traditional 401(k)s and IRAs are required after age 70 ½, and you must pay income tax on each distribution. But if you remain employed after age 70 ½ and don't own 5 percent or more of the company you work for, you can continue to delay withdrawals from your current 401(k) plan and the resulting income tax bill until you actually retire. "If the money is inside the 401(k) plan, they are not required to take distributions on that as long as they are still working and not a major shareholder in the company," Sheehy says. However, you will need to take required withdrawals from IRAs and 401(k) plans from previous jobs after age 70 ½, regardless of your employment status, to avoid a stiff 50 percent tax penalty.
You have company stock in your 401(k) plan. Company stock gets special tax treatment when it is held in an employer-sponsored 401(k). When company stock is distributed from a 401(k) plan the sale may qualify for the long-term capital gains tax rate, which for many people is lower than their ordinary income tax rate. But if the company stock is transferred to an IRA, the appreciation will be taxed at the often higher ordinary income tax rate when it is withdrawn from the account. "There's a tremendous tax opportunity when you hold company stock in your 401(k)," says Mary Kusske, a certified financial planner and president of Kusske Financial Management in Burnsville, Minnesota. "Instead of the stock coming out as ordinary income, it will be taxed as a capital gain."
Your 401(k) plan has especially low fees. Many 401(k) plans are plagued by high fees and poor investment choices, and a job change finally allows you to shift your savings into lower cost investments. But some companies carefully select unusually good investment options for their workers and use their bargaining power to negotiate especially low investment fees for participants. If you're in a best in class 401(k) plan, and you've shopped around to see that you can't reduce your investment costs by switching to an IRA, sticking with a former employer's 401(k) plan can help your money to grow faster. Just make sure to keep your contact information up to date, including an email address and phone number not associated with your former job, so you don't lose track of the account. "If the 401(k) has low-cost funds, and maybe the employer is picking up the expenses for administration or a financial adviser, you might want to keep it in the 401(k) because you might have to pay for professional management outside the 401(k)," says JoAnn May, a certified financial planner for Forest Asset Management in Berwyn, Illinois. "If a 401(k) is filled with high-expense mutual funds, that's a reason to get it out."
You haven't had time to carefully evaluate your options. Changing jobs is a hectic period when you need to create a new routine, and you might not have a lot of extra time to shop for the best IRA and compare the investment options and costs in your old employer's plan to what's available in your new firm's 401(k) plan. But you don't need to move your money immediately upon leaving a job. "There is no reason to make a fast movement," May says. "Leave it there until you figure out what you want to do."
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