RETIREMENT
to the one managing the IRA . A rollover between similar accounts — from a traditional 401 ( k ) to a traditional IRA , say , or from a Roth 401 ( k ) to a Roth IRA — is tax-free and typically the least expensive option . Rolling over assets from a traditional 401 ( k ) to a Roth IRA , however , will generate income taxes .
Some clients prefer an indirect rollover , meaning they receive a check from the 401 ( k ) and redeposit it themselves into the IRA of their choice . This is risky , say experts , because there are penalties for not moving the money within 60 days . The IRS might view the 401 ( k ) distribution as a taxable withdrawal , not a rollover , and there could be additional penalties as well .
Worse still , market watchers warn , in many cases employers are required to withhold 20 % of 401 ( k ) withdrawals for potential taxes . For the indirect rollover to satisfy the IRS , the full amount must be transferred to IRAs . So clients have to come up with funds to compensate for that 20 %.
Why Stick With Your 401 ( k )?
But even with the advantages of rolling over , advisors say there are circumstances where it may be best to leave funds in a 401 ( k ).
“ Most 401 ( k ) participants are in large plans with low fees and an adequate number of good investment options ,” says John Turner , director of the Pension Policy Center in Washington , D . C . “ Also , most participants have low financial literacy , which means that they are not capable of dealing with a wider range of financial assets with differing levels of fees . Thus , most participants are better off staying in their 401 ( k ) plans .”
There are other downsides to rolling over — for instance , you lose the ability to take loans from your employer plan . “ Rolling over a 401 ( k ) to an IRA might be a bad idea if you anticipate needing a loan from your retirement fund , as most 401 ( k ) plans allow for a loan up to the lesser of half the account value or $ 50,000 ,” which IRAs don ’ t , says Dina Leader Powers at Fairway Wealth Management in Independence , Ohio .
It can be hard for clients to choose their own IRAs , too , if they don ’ t have financial guidance tailored to their particular situation , Powers adds . Many 401 ( k ) s benefit from managers with a fiduciary obligation to their members . Furthermore , 401 ( k ) assets might be in a target-date fund that automatically rebalances the client ’ s portfolio over time , she says ,
A rollover between similar accounts — from a traditional 401 ( k ) to a traditional IRA , say , or from a Roth 401 ( k ) to a Roth IRA — is tax-free and typically the least expensive option .
so they don ’ t have to worry about their portfolios .
Another advantage of the 401 ( k ) is that it often allows people to take penalty-free emergency withdrawals at younger ages than they could in IRAs . “ In many 401 ( k ) plans , you can withdraw from your account in retirement without a penalty at age 55 ,” Powers says . “ You don ’ t have to wait until you are 59½ , like with an IRA . This can be useful if you retire early .”
In addition , the size of many 401 ( k ) plans gives them scale , which means they can charge less for investment purchases and advice , says Brett Bernstein , CEO of XML Financial Group in Bethesda , Md .
For Bernstein , the rollover decision boils down to four key questions : What is the client allowed to do with the funds if they stay in the 401 ( k ) after retirement ? What investment choices does the 401 ( k ) offer ? What are the costs ? And what access to personalized financial guidance does the 401 ( k ) provide ? “ Once those questions are answered , you can make an educated decision about what is best ,” he says .
A 401 ( k ) plan also offers more protection to clients facing or anticipating legal troubles or bankruptcy claims , says Kurt Whitesell , a vice president at Summit Wealth Group in Rapid City , S . D . ( he ’ s also a CFP Board ambassador ). “ If you are in the middle of a lawsuit or have one pending , rolling over your 401 ( k ) could be a bad idea . ... The protections within a 401 ( k ) are stronger than they are for IRAs .”
Still , clients who choose IRA rollovers have the option of working with their own trusted advisor , he adds , which can be a distinct advantage — particularly if the clients aren ’ t financially sophisticated . “ Many 401 ( k ) plans may offer help , although when you call the 800 number you have no idea of the experience of the customer service representative on the other end of the call ,” Whitesell says .
Another consideration in choosing a rollover , he says , is that traditional IRAs can later be converted to Roth IRAs . That triggers taxes , but the money remains tax-free after that and eliminates required minimum distributions . Alternatively , IRA holders age 70½ or older can donate up to $ 105,000 to charities instead of using that money for RMDs , he says . Neither of these options is viable for 401 ( k ) s .
For some clients , estate planning will also be a factor . When an IRA account holder dies , the IRA automatically passes to named beneficiaries . If no beneficiary is specified , however , the IRA goes to the estate and to probate , which can be complicated and expensive . The rules are a little different for 401 ( k ) s — with those , at least half of all assets must go to a surviving spouse if there is one , unless specific instructions were left for some other beneficiary . Again , if there is no spouse , heirs may be looking at probate .
Of course , retirees can always simply liquidate their old 401 ( k ) s and put the money in the bank . Advisors don ’ t typically recommend this , though , since penalties and taxes will likely be due . “ Cashing out is hardly ever a good idea ,” says Turner , noting a possible exception if the client has a small 401 ( k ) with only a few thousand dollars in it and desperately needs the extra cash .
52 | FINANCIAL ADVISOR MAGAZINE | OCTOBER 2024 WWW . FA-MAG . COM