There are several reasons you may want to move your 401(k) to an IRA. It might simply be to consolidate your investments or to get away from unnecessary fees. It might be to make a Roth conversion. It might be to obtain an active money manager or work with a more holistic advisor. Whatever the reason, moving money out of your 401(k) or any other retirement plan may not be as simple as it appears.
Though it may only take a call and/or a little paperwork, there may be some crucial planning opportunities and/or pitfalls you would miss if you are not careful. Here are just a few:
- The Magic Window…Many retirement plans allow you to access funds at age 55 without that nasty 10% penalty as opposed to an IRA, which is 59 ½. This can come in handy if you retire early and even more so if your retirement plan offers an attractive investment for short-term money, such as a Guaranteed Interest Contract (GIC) with a high rate. If you know anything about our investment process at KFS, you know we like to bucket money for income needs. This can be essential to an overall plan and the good news it isn’t all or nothing. You can leave some and transfer some if that is what makes the most sense.
- After-Tax to No Tax…Unless you ask, you may not know whether or not you have after-tax dollars in your retirement plan. Many people do and are surprised to find out it’s there. Even better is that under current law, you can send those dollars straight to a Roth IRA. Bearing in mind all the rules around a Roth, this could mean those dollars will now grow tax-free and come out tax-free at some point in the future.
- Company Stock Jackpot…If you own your company’s stock inside your retirement plan, you could potentially have a home run! NUA (Net Unrealized Appreciation) stock gets some pretty special tax treatment. Rather than rolling your entire retirement plan to an IRA and taking distributions at “ordinary” income tax rates, this type of stock gets distributed during the IRA transfer to a non-retirement account. In this case, your “ordinary” income tax bill is now only the cost basis in the stock, which is often much less than the total value of the stock. If you follow the other rules of the game, the rest of the distribution will be taxed at “long-term capital gains” rates. This type of taxation is usually lower, sometimes significantly lower, than “ordinary” income rates. Which could result in tens of thousands if not hundreds of thousands of dollars over your retirement. Sound complicated? It is! You definitely need some professional guidance with this one.
- 72 is the new 62!... Not really, but your tax return may believe it. If you are still working at the young age of 72 and your dollars are sitting in your retirement plan through your employer, you do not have to take a Required Minimum Distribution (RMD) - the mandatory distribution from your IRA that can hit your tax return by storm. Because IRA distributions are usually taxable (at ordinary income rates), they are added to your income and can generate even higher taxes and costs in other areas like the amount of tax on your Social Security Income and your Medicare Premiums.
- Nuances and Nuisances…There are several other “little” factors than can have impacts and shouldn’t be ignored. First, it might not make financial sense to make a move. You have to look at the investments and investment options themselves, a fee comparison, and alternative solutions such as rolling it to your next employer’s plan. What services are available as a plan participant? What are the costs? Also, do you have a loan against your plan? You will have to pay it off prior to the transfer. Might you need one at some point in the future? Are there annuitization options? Would these be a good thing for you?
The bottom line is you need to look at the bottom line. How you transition your 401(k) may not be as simple as it seems. The good news is this obviously ain’t our first rodeo, so you don’t have to go it alone!