A 401k rollover is often pitched as a smart way for you to take more direct control of your retirement money once you leave your job. Unfortunately, though, that pitch frequently comes from a financial advisor who stands to profit based on how much of your money you're willing to hand over.
Despite the reality that executing a 401k rollover can indeed be a shrewd move, it's not always the best choice when you leave a job. Whether or not it makes sense for you depends on several factors. Key ones include:
- How old you are at the time you leave your job
- Whether you expect to keep working elsewhere or are outright retired
- What the costs and investment options are within the 401k plan
- Whether you plan to convert your money into a Roth IRA
- How exposed you are to legal actions or other judgements
401k rollover watchouts
As long as your 401k account has a vested balance of more than $5,000, your former employer can't force you to leave the plan once you stop working for the company. That gives you time to make an educated decision based on your personal circumstances. If your vested balance is below that threshold, your company may force you out of the plan. If you do get forced out, you generally have 60 days to roll your money into another qualified plan before that money gets treated and taxed as a withdrawal.
Aside from getting forced out due to a low balance, there are times when taking a 401k rollover could be a great idea. That's particularly true if you're at or above age 59 1/2 and ready to retire and stuck with a 401k plan that's chock-full of high cost mutual funds and/or significant participant-paid costs. If those factors don't apply to you, there could be some very good reasons to keep your money in your former employer's plan, at least for a little while.
Why your age matters. If you're separating from service between the ages of 55 and 59 1/2, and are done working altogether, there's a huge advantage to tapping your retirement funds directly from your 401k. There's typically a 10% penalty if you withdraw money from a retirement plan before age 59 1/2. That penalty doesn't apply to money coming directly out of your 401k, however, if you turned at least age 55 in the year you separated from service from the company.
Why your continued work plans matter. If you plan to keep working, you can often roll your 401k balance from a former employer directly into the 401k plan of your next employer. If you roll the money into your own IRA in the interim, it frequently gets more complicated to later perform the "reverse rollover" into the 401k of your next employer. Additionally, not all employers allow such reverse rollovers.
This is particularly important if you expect to keep working past age 70 1/2. If you're still an active employee of a company and not a "5% owner" of that business, you can continue to contribute to your 401k plan and are not subject to required minimum distributions from that particular 401k plan. If you moved your money to a Traditional IRA and couldn't get it into your new employer's 401k, that IRA would be subject to required minimum distributions once you reached age 70 1/2.
Consider the costs of going elsewhere. Big investors can typically negotiate lower costs for their investing services, and your former employer can negotiate its fees based on the total amount invested among all of its 401k participants. Particularly if you invest in mutual funds or take advantage of any plan-provided guidance or tools in making your investing decisions, you might find leaving your money behind could have significant cost advantages vs. taking that rollover.
Think about any potential Roth IRA conversions. If your original account was a Traditional 401k, and you'd like to eventually convert that money into a Roth IRA, it might make sense to keep the bulk of it in the 401k and only rollover the amount you plan to convert each year.
This is because the rules on Roth IRA conversions consider your total balance and basis of all your Traditional IRA accounts -- and not your 401k accounts -- when figuring out the tax treatment of your conversion. The accounting, paperwork, and hassle can get very complicated if you have other money in Traditional IRAs, particularly if you're still working and contributing new money to those accounts.
Weigh your legal risks. 401k plans have better Federal legal protection against creditors than IRAs do, and levels of creditor protection for IRAs vary by state. While you may very well go through life without facing the risk of a serious financial judgement or major unplanned cost, it's certainly worth at least considering the potential of facing the losing end of a substantial expense.
Jump in with your eyes wide open
Even with those caveats, a 401k rollover may very well be a great decision for you to make. If your 401k has high costs and/or your investment options are limited to expensive mutual funds, or if you can successfully manage your own investments, or if you're working through a Roth IRA conversion strategy, then a 401k rollover might still make sense.
Likewise, there can be great reasons to roll a 401k from a former employer into your current employer's 401k. For instance, you might want to take advantage of the age 55 penalty-free early withdrawals from your new employer, or you might want to keep working and not be forced into required minimum distributions at age 70 1/2.
Whatever your reason for considering a 401k rollover, plan for it with your eyes wide open to the drawbacks as well as the benefits. That way you can be certain that whatever decision you make will be the right one for you.