In this month’s edition of “Money Matters,” Scott talks about rolling over your 401k to an IRA, factors to consider in this decision, and how this decision can have positive and negative effects on your financial future depending on your situation. Listen to learn more about rolling over a 401k to an IRA.

Money Matters: Rolling Over a 401k to an IRA

0:00:00.1 CJ: WTIP is pleased to bring you another edition of Money Matters, a monthly feature intended to help us understand more about managing our finances. Scott Oeth is a certified family... I did it again, Scott. Certified financial planner and adjunct professor. He works with many individuals and has taught retirement planning and wealth management strategies to hundreds of financial professionals. And he's joining us now by phone. Welcome, Scott.

0:00:27.3 Scott Oeth: Good morning, CJ.

0:00:28.3 CJ: I'm determined to give you an extra career there. I don't know. Is it got to be my nursing background? I don't know.

0:00:36.9 SO: I've studied lots of stuff, but probably not enough in family planning.

0:00:41.8 SO: Don't attribute that to me yet.

0:00:43.7 CJ: Okay. All right. All right. All right. So, we want to talk about rolling over from a 401k to an IRA. So, when exactly do people have a choice to do that?

0:00:55.3 SO: Yeah. So, CJ we trade some messages, and this is a common question. This is one that comes up all the time that we address with clients, or I hear different places. So, when someone leaves their employer retirement plan, and we're often thinking about a 401k, that qualified retirement plan that companies offer, but this could also apply to a 403b plan, if you maybe were a nurse, as you say, or a teacher, or if you're lucky enough and you work for a company that has one of those traditional pension plans, you often have an option to do a rollover of that into an IRA, individual retirement account. So, it's a big decision. And it comes up a lot, CJ.

0:01:34.4 SO: When you look at statistics, your average American, by the time they're approaching retirement age has had as I saw, it's like over 10 different jobs or a dozen different jobs. And so, the big issue as I see it is, we'll touch on some of the advantages of rolling into an IRA versus keeping it in that 401k or 403b. I think the main thing I would encourage people is just watch out for these sorts of orphaned and forgotten accounts. That's very common. People work somewhere for a while, then they move on, and there's money left in that employer plan, and they just sort of forget about it. Sometimes that works to their advantage because it's sort of like the Rip Van Winkle investing approach, but often it leads to their overall assets. You want to understand how they're positioned, make sure they're working for you, and they're appropriately invested.

0:02:24.3 SO: So, you want to watch out for these orphaned plans. Just to touch on it quickly, first of all, CJ, this on the surface can seem to be a fairly simple decision, but there are quite a few nuanced points, and I encourage people to take it seriously, do their own research, seek expert advice, especially if you're talking about a significant dollar amount as you're approaching retirement. There can be some real significant little hitches one way or the other between IRA or 401k. But basically, like I say, if you leave your previous employer, or maybe you did a long time ago and there's an old plan balance there, you can do a tax-deferred rollover into a new individual retirement account, continue the tax shelter until you take the dollars out, or even beyond if you chose the Roth option.

0:03:07.1 SO: Another good option for a lot of folks is if you are a new employer, a new workplace, and you like the plan that's available there, if the plan allows it, you could roll those old balances into your new workplace plan. Sometimes that's a good option. It simplifies things, it consolidates it, puts it all in one place. Also, if the company allows it, you can maintain those old balances, but more and more we're seeing some employers, after a period of time, send you a letter, they take these funds and they essentially kick them out. They don't want them. They don't want the overhead. They don't take responsibilities of old options. But if you really like that old plan, you might be able to maintain it. I'd say just don't forget about it. Make it a conscious decision. And then, CJ, there's another option that a lot of people choose, and they may have good reasons to do so, but I think it's probably not advantageous in many cases.

0:04:01.5 SO: And that's, you can cash it out. So, if you leave an old employer, you've got money in that 403b or 401k, you can simply pull the money out and spend it or pay down debt or have a vacation or something like that. It just occurred to really make sure you're thinking through your overall financial goals and the big picture before you can sort of take the money and run. The big problem, CJ, is you're pulling it out of a tax shelter environment and it's very likely that state and federal income taxes would apply. And if it's before age 59 1/2, you're likely to also pay a 10% early withdrawal penalty.

0:04:35.3 CJ: I was wondering about that. Yeah.

0:04:37.2 SO: Yeah. Usually not the option we're recommending.

0:04:40.8 CJ: So, advantages to leaving it in the old 401k. I mean, you don't want to forget about it, but are there advantages to just leave it sit where it is?

0:04:53.5 SO: Well, I think the big advantage with leaving it to an old plan in an old plan or rolling to an IRA, a couple of the big ones that people are thinking about right off the top are what are the investment selections and what are the costs and fees involved? And then there's, maybe I'll touch on a few of the nuances of different little tax law differences, but very commonly 401k or employer retirement plan usually has a pretty good investment lineup. But I view it as sometimes, CJ, like you and I are going to, hey, let's meet up for lunch. We go to a restaurant and there's the lunch menu, which is kind of a short menu with six, seven, eight different options on there that that restaurant has provided. And that's from an investment standpoint, sometimes what that employer 401k or 403b feels like is a short, constrained list of investment options. So sometimes there's one international stock fund, one bond fund, no real estate funds. Things like that versus choosing to move your money to an individual retirement account. An IRA is like walking into a mega restaurant and food warehouse where you can choose almost any investment option. So wide open.

0:06:10.0 SO: So, for many people, they like that idea of being able to broaden their investment approach, consolidate it with other IRAs, have their money in one spot, choose one custodian where you can see everything instead of, oh, I have to log into this old retirement plan. And then, the fees and expenses that can really go either way. So large employers, if they're doing a good job, will often be embedded investment expenses in that 401k or that qualified retirement plan. They might be low and quite affordable. However, if you shop around and do some good decision-making, IRA accounts have gotten very low cost as well, but that would be something to consider as well. Is what are the expenses? Many small company retirement plans, I'd say, CJ, are not necessarily cheap and you don't always see the cost. It's assessed versus the asset value of the plan and it may in fact be cheaper to roll your money to an IRA.

0:07:05.7 CJ: Got it. So, need to do a little research is what you're saying as you usually say when we have these conversations.

0:07:12.9 SO: Yeah. I think do some research and like say, if this is feeling like a big decision, this would be a great time to talk to a good experienced certified financial planner and ask them to really weigh the options and not just kind of go with the default. Say yeah roll to an IRA. CPA could also be a good option. Because there's quite a bit of nuance. Some of the things maybe just a quick touch on CJ. The IRA, there are less restrictions typically for Penalty-Free Withdrawals for things like first-time home purchase or college expenses. So, avoiding that 10% penalty, we talked about the investment options with the IRA. This is often the big one just that really big selection including there's even what's called self-directed IRAs as some trust companies offer where you can. This gets very complicated, but you can buy things like real estate and different out of the box type investments in there.

0:08:15.0 SO: If you work for a big employer and you have company stock in your 401k plan, you really need to take a close look at this, because there's a special exemption in the tax code called net unrealized appreciation, NUA where you might have the potential to do a special type of rollover where you peel out that company stock and you're able to get capital gains treatment on the appreciation that's built up in there. You pay income tax on the basis, so if you keep it in 401k and you just pull it out, you'll pay ordinary income tax. So that can be a big advantage. And I think, for younger folks that penalty free distributions, higher education expenses, folks for retirement age, the IRA, when you take money out of your employer retirement plan, your 401k, there's mandatory withholding and you might be paying your taxes elsewhere and not want that. There's also, like you said, CJ, if someone gets retirement agents, they've worked at 8, 10, 12 different employers and they have all these old 401ks, when it comes time to take required minimum distributions, which you and I have talked about in the past, you will need to do, take that withdrawal from each 401k plan versus an IRA. If you put them all in one individual retirement account bucket, you can just take one withdrawal from there. It simplifies things quite a bit.

0:09:28.3 CJ: Yes. I hadn't thought of that. Yeah.

0:09:30.8 SO: Yeah. Something else you and I talked about is there's this great option for folks who are over 70, they're retirement age. You can make what's called a qualified charitable distribution. So, if you are charitably inclined, there's an organization you'd like to support, the ability to make a distribution directly from your IRA to that charity and not have it show up in your tax return. There are some special rules around this, but those pre-tax assets can be a wonderful thing to leave to your favorite cause or your favorite 501C3 because they don't pay tax on it, or you would otherwise. But if I can touch very quickly, the employee retirement plan, there are a couple important things there. If you're in a 401k and you're employed or you roll that to your new employer's plan, you may have the opportunity to take a loan. You're not able to do that with an IRA and creditor protection. If you think you're at risk for being sued or a lawsuit, 401k plans, employee retirement plans generally have very strong levels and those assets are protected.

0:10:29.4 SO: Different states have creditor protection for IRA balances, but not all of them. And there's different limits. So that's a legal area, and if you think that's an issue for you, get some good legal advice on whether it makes sense to have money staying in that 401k plan to new 401k plan or have it in IRA. And if you're getting divorced, you want to check into the rules around this. Both types of retirement accounts can be split in a divorce settlement, but if when the spouse needs to take money out before 59 1/2, the qualified plan side in this case can be liquidated without the penalty. So it gets in the weeds. One last big one.

0:11:09.5 CJ: Yep.

0:11:10.2 SO: If you're over 55 and you leave and your money in a 401k plan, you can access it without that 10% penalty versus the IRA, it's age 59 1/2. But even with that, there's some wiggle room. So, a lot of decision points. Get your expert advice.

0:11:25.8 CJ: Exactly. Expert advice is key. All right, Scott, thank you so much, so much to digest there. We'll put it up on the website and people can go to your website as well to get more information on this. Can you give that to us please?

0:11:41.9 SO: Yeah. Very simply. It's scottoeth.com.

0:11:46.3 CJ: All right. Thank you, Scott.

0:11:48.5 SO: Thanks, CJ.