Though clients come to Bull Oak for a variety of San Diego financial services, a common question we’re asked is “should I rollover my 401k?”
The answer is, perhaps. For most, it makes sense to roll your mutual funds out of a 401k (this includes a 403b, 401a, or whatever type the deferred employer plan may be). Though, there are a few exceptions that one must consider before pulling the trigger. This includes fees, any concentrated stock positions, and other company benefits.
When you leave your company, you essentially have four 401k options to consider.
Your Four 401(k) Options
1. Completely cash-out your retirement funds from your 401k (not recommended)
– You do NOT want to do this outside of any cosmic cataclysmic circumstances (e.g. the apocalypse has arrived, the moon is crashing into the Earth, etc.).
– If you do, be prepared to pay the IRS as this is considered a taxable event. I recommend that you talk to a tax professional before you consider this option. 401k distributions can be taxed at the ordinary tax rate plus a 10% penalty if you are under 59 ½ years of age.
2. Leave your funds at the old 401k
3. Roll your funds to a new 401k (your new employer)
4. Roll your funds into a Rollover IRA (Individual Retirement Account)
Of these four options, there are really only three non-taxable paths you will want to consider: Leave your funds where they are, roll them over to another 401k, and roll them over to an IRA.
Option 2 & 3: There are a few good reasons why you would want to keep your funds in a 401k plan. The biggest reasons include:
1. Lower Fees: If the plan has rock-bottom fees, then it probably makes sense to have your money there, whether it is the old or the new 401k plan. Though, most discount brokerage companies have access to extremely cheap products, such as Index ETFs (e.g. Charles Schwab, TD Ameritrade, etc.)
2. Stronger Protection Against Lawsuits: 401ks are protected against lawsuits and bankruptcies while IRAs are only protected against bankruptcies up to $1.28MM.
3. Ability to Borrow Against Funds: You cannot borrow against an IRA, but some employers allow their employees to borrow against their 401k balance (amount depends upon the plan). While I rarely think this is a good idea, it may be helpful under certain circumstances.
Why You Should Rollover To IRA
Option 4: While credit protection is weaker and while you cannot “borrow” against an IRA, there are many advantages to rolling your funds to an IRA. These include:
1. Better Investment Choices: 401k’s are notoriously limited with their investment choices. IRAs open the investment universe to all mutual funds, individual stocks and bonds, ETFs (my favorite), and thousands and thousands of others. You can also hire an investment advisor to manage your IRA if you are unwilling/unable to (like us!).
2. Roth IRAs: Most 401ks do not offer a Roth option. As a recap, a Roth IRA requires you to pay tax at the point that you put funds into the Roth, but grows tax-free and can be distributed tax. This can provide tremendous value down the line. If you have a Traditional/Rollover IRA, you have the option of converting this account to a Roth. We work with the best Tax Attorneys/CPAs in San Diego when considering and planning for this option.
3. Can Take Early Distributions From A Roth: Well, technically these aren’t “early” distributions, but you can take money out of the account with no withdrawal penalty if you’re under 59 1/2 years old. Of course, there are exceptions (contributions vs. earnings, down-payment for your first home, etc.), but the flexibility the account offers is fantastic.
4. Fewer Rules / Greater Opportunities: 401ks are heavily regulated, limiting the number of investment choices and opportunities available to those accounts. IRAs are standardized by the IRS, allowing multiple brokerages to follow the same rollover rules.
5. Better Beneficiary Selections: IRAs often allow greater flexibility when selecting your beneficiary. Many 401ks usually offer only one primary beneficiary.
6. Consolidation: Most people have 7 careers throughout their lifetime, often leaving old 401ks behind. Keeping your funds within one single account can make your financial life simpler. Rolling your 401k into an IRA is a free, tax-advantaged process.
If you are considering rolling over your 401k and would like guidance on the procedure, we are more than happy to answer any questions you may have. Feel free to schedule a time to talk with us.
The Importance of 401(k)s & Retirement Planning
The choice whether or not to roll over your 401(k) can play a significant role in your retirement planning. The expected return you should receive on your retirement funds and assets depends upon the number of fees involved and the proper asset allocation. As stated before, many employer retirement plans have excessive hidden fees. And many participants do a poor job of properly allocating their own assets. The difference between these two choices may not seem like much in the short-term. However, over the long-term, due to compounded returns, the choice can be significant. Therefore, it is important for these individuals to choose wisely.
Furthermore, having a tactical strategy regarding when and how to pull funds from your individual retirement account (401k, IRAs, etc.) is a critical component when planning for your future. We like to consider the tax impact of such strategies by forecast the client’s effective tax rate. We suggest that these individuals run multiple scenarios to see which strategy makes the most financial sense for their retirement plans.
Consult an Expert
While the act of rolling over or not rolling over your 401(k) is a simple, deciding whether or not to can be a difficult one. As a fiduciary financial advisor, we like to consider this question by forecasting both options. Whichever options make the most financial sense, and by assuming that the client is able to effectively diversify within their retirement plan (not a given), that is the baseline option the client should choose. We are experts when it comes to creating cashflow-based financial plans. If you feel like you can benefit from creating a financial plan, please do not hesitate to contact us for transparent investment planning in San Diego.
While the information presented herein is believed to be accurate, Bull Oak Capital LLC (Bull Oak) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Bull Oak is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Bull Oak makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Bull Oak or its employees may have an economic interest in securities mentioned herein.