When To Roll Over Your 401(k) -- And When Not To

To roll or not to roll, that is the question — at least when you’re changing companies or retiring.

Sometimes it’s a good idea to roll over your 401(k) to an IRA, and sometimes it's better left right where it is. In order to make that decision, you need to weigh what is important to you.

Here are some options when you change employers or retire:

1. Leave your funds in your former employer's plan - if available or permitted (not always allowed by every plan and every employer so you’d have to ask the HR department.)
2. Roll the funds from your former employer’s plan into a new employer’s plan - if permitted and available.
3. Roll the funds from your former employer’s plan into an IRA.
4. Cash out and pay taxes (and early withdrawal penalties, if applicable.)

The best choice isn’t always immediately clear. Here are some considerations to help you with your decision. Which of the following is most important to you?

Simplicity

You may prefer to consolidate your accounts in one place or a limited number of places in order to better stay on top of your money. If your goal is to keep things as straightforward as possible, consider option 2 or option 3 (if you already have an IRA).

Investment options

Sometimes your investment options are limited within your employer's plan. An IRA rollover account, in contrast, leaves a plethora of investment options open to you.

Consider option 3 if your employer’s (or former employer’s) plan lacks investment options that interest you.

Lower fees and expenses

Run a side-by-side comparison of fees and expenses in your current 401(k) and the IRA you are considering . Look at account management fees as well as administration fees and sales charges. (Click here for a resource on fees and here for a resource on creative ways to reduce them.)

Options for beneficiaries

Traditional IRAs have a special "stretch" provision for beneficiaries that may be able to extend the benefits of an IRA for future generations. An IRA beneficiary – even when the beneficiary is not a spouse – may be able to take an annual “Required Minimum Distribution” based on their (longer) life expectancy instead of having to close the account and pay the taxes within a short period of time. In other words, they may be able to trickle the required withdrawal payments (and subsequent tax liability) each year allowing the funds to grow and “stretch” on for years.

If this benefit interests you, check with your IRA custodian to make sure your plan allows annual withdrawals for a beneficiary over their life expectancy.

A 401(k) may be harder to stretch out for future generations. In an ERISA qualified retirement plan such as a 401(k) or 403(b), a spouse can generally stretch out their distributions over their life expectancy.  Non-spouse beneficiaries, however, may have more limited options. The terms of the plan may determine how your plan provider may treat funds. Your 401(k) plan may not include a stretch provision.  (See: IRS Publication 575.)

If you want to stretch your IRA for future generations, consider option 3. Consult with your qualified tax advisor and see IRS Publication 590.

Retire early

Are you planning on retiring before you reach age 60? If you plan to retire after age 55 and before age 59 1/2, a rollover (to an IRA) might not be in your best interest. Not everyone realizes this — if you retire from your current employer and are over age 55, you can withdraw funds from your 401(k) without incurring an early withdrawal penalty. In contrast, an IRA carries an early withdrawal penalty until after age 59 1/2. (See IRS.gov retirement topics.)

If you plan on retiring early, consider option 2 and roll over any former employers’ 401(k) plans into your current employer’s plan.

Protection from creditors and judgments.

This starts with “it depends.”

I talked to attorney, Dan Hill, with Snow, Christensen, and Martineau in Salt Lake City, Utah who is a FINRA arbitrator and securities attorney with close to 30 years of experience. Hill shared, “Judgments and lawsuits have different analysis than bankruptcy. Start by considering what you are protecting the asset from.”

“If you are concerned about protecting your assets from judgments and lawsuits, keep your funds in an ERISA protected qualified retirement plan,” says Hill.  ERISA qualified plans include a 401(k), deferred compensation plans, profit sharing plans and many welfare benefit plans such as an Health Savings Account (HSA.) “Since these plans are exempt from judgment creditors,” Hill suggests, "if you are worried about judgments, you may want to keep your funds in the ERISA qualified plan.”

In this case, you’d go with option 1 or 2. If the personal risk of bankruptcy is a concern or a possibility, Hill states, “It’s difficult to make generalizations but there are protections from creditors in bankruptcy in an IRA.

The Bankruptcy Abuse and Consumer Protection Act (BAPCPA) of 2005, provides bankruptcy protection up to $1.24 million (indexed for inflation.)” Under BAPCPA, ERISA qualified plans are protected from creditors in bankruptcy. If one is concerned about a personal bankruptcy risk, your employer’s retirement plan may be the safest place. However, an IRA is protected, too, and up to a fairly high limit -- about $1.24M in 2015 which should cover most people.

If you are concerned about protection against the personal risk of bankruptcy, consider option 1, or 2 and if your funds are under $1.24M, you can also consider option 3.

This should go without saying, but to be clear, if asset protection is a concern, consult an attorney to discuss your specific situation. It’s complicated.

Working well into your twilight years.

Still working after normal retirement age? Some employer plans allow older employees to avoid taking a required minimum distribution (RMD) if they are still working. When accounts are rolled over to an IRA, investors must take their minimum distributions once they pass age 70 1/2. (The IRS talks about this here and in Publication 560.)

Minimizing taxes on company stock

Do you hold employer stock in your 401(k) that has gained value? If so, you may want to consider option 3 with a twist. The IRS allows you to roll over your funds to an IRA while separating out your shares of stock from the other funds and depositing the stock into a non-qualified (non-retirement) account. This is called Net Unrealized Appreciation (NUA.) The caveat here is that you'd have to pay taxes on your basis — what you paid for the stock shares — but the gains aren’t taxed until you actually sell the stock. Then the gains are subject to long term capital gains tax (as long as you held it for over a year.) Long term capital gains are taxed at a lower rate than ordinary income tax which the 401(k) and the IRA are subject to.

If this is something you are considering, discuss it with your qualified tax advisor and/or financial planner well in advance of making your transfer.

To roll or not to roll? That is the question. The answer depends on what's important to you.