I believe most people should rollover their 401(k) to an IRA when they leave an employer. The reasons are many: more investment options, greater control and flexibility over how you manage your retirement savings, and potentially better tax options when you make distributions or your pass your retirement account to your beneficiaries to name just a few.
Yet, according to Hewitt Associates, only 23% of all employees rollover their plan to an IRA or other employer’s retirement plan when they leave their job. While an IRA may be the right choice for a lot of people, there are some situations in which it may make sense to leave your 401(k) at your employer.
Following are 3 reasons you may want to leave your 401(k) at work:
1) You plan to take distributions between the ages of 55 – 59 1/2. Distributions from retirement plans, whether an IRA or a 401k(k) are generally taxable. However, if you are under the age of 59 ½ there may also be a 10% penalty assessed on distributions from an IRA. Distributions from 401(k) plans avoid the 10% penalty if the account owner is age 55 or older during the calendar year they separate from service. For workers who want to retire earlier than age 59 ½ this may be an opportunity to begin distributions without the added burden of the 10% early withdrawal penalty that is assessed on IRAs. To be clear, workers must be over the age of 55 when they separate from their employer, not at the time they make a distribution from their plan. For example, a 56 year-old who separates from his employer may make penalty free, taxable distributions from his plan. A 56-year old worker who left his employer at the age of 54 would not be able to avoid the 10% penalty even though he is over the age of 55 at the time the distribution was made.
2) IRAs in your state may be vulnerable to creditors. 401(k) assets are governed by the Federal rules of ERISA and are protected by creditors. If you get sued, your 401(k) is protected. IRAs are not subject to ERISA. Depending on what state you live in, it’s possible that your IRA accounts could be vulnerable to creditors in the future. In the State of MN, IRAs are generally protected from creditors. If you are a MN resident and you are sued, your IRA assets are not vulnerable to creditors and have similar protection as 401(k) and other retirement accounts regulated by ERISA.
3) NUA. NUA or Net Unrealized Appreciation is a strategy that may allow an employee with company stock to take that stock out of his 401k plan and pay ordinary income tax on the cost basis of the stock and capital gains taxes on distributions of the gains. Briefly, here is how it works: Let’s say you work for ABC Public Co. You have $1,000,000 of company stock and the cost basis of that stock is $100,000. NUA allows you to distribute stock from your 401(k) plan and pay ordinary income tax rates on $100,000. When you sell shares in the future, you will pay capital gains taxes on the remaining $900,000. NUA strategies can be complex and certain rules need to be followed, but in the right situations they might provide an opportunity to reduce the tax burden on your retirement savings.
Unless you fall into one of the scenarios above, I believe it’s usually in your interest to take control of your retirement savings through an IRA.
Naturally, there are exceptions to every rule. Now you know three.
Required Disclosure: “As each individual’s tax situation is different, take time to consider all the facts and consult with your tax advisor before initiating a rollover. Distributions received before age 59 ½ are subject to an early distribution penalty of 10% additional tax unless an exception applies. This information is not intended to be a substitute for specific individualized tax, legal or estate planning advice.”