Should You Roll Over Your 401(k)? 5 Questions to Ask Yourself Before Deciding

Rolling over funds from their 401(k) into an IRA is one of the most common moves people make with their retirement savings. This idea of consolidating everything into one account may sound attractive at first, but the question becomes: Is such a rollover the right solution for you? Like many financial decisions, what looks like a simple decision at first can turn out to be complicated.

The real question is: Will you lose or gain any benefits by rolling over your 401(k)?

The answer depends on how you are affected by the rules. To help you make an informed choice, here are five smart questions to ask before making your decision.

Note: In this article, 401(k) is used to refer to all employer retirement plans, including profit-sharing plans, 403(b)s, and governmental 457(b) plans.

1. Are You Under Age 59½, and Could a Rollover Trigger the 10% Penalty?

If you are under 59½, taking money out of a retirement account usually triggers a 10% additional tax or early distribution penalty, unless you qualify for an exception. Here is the key point: Some exceptions that apply to a 401(k) do not apply to an IRA, and in those cases, rolling your 401(k) into an IRA could cause you to lose that exception.

Example: One taxpayer owed over $20,000 in penalties after rolling his 401(k) into an IRA and then withdrawing money from the IRA. He knew that he qualified for the “age-55 rule,” which allows penalty-free distributions (that occur after separation from the employer) from a 401(k) if the employee leaves their job in or after the year they turn 55. What he did not know is that this age-55 rule does not apply to IRAs, and by rolling over to an IRA and then taking the distribution, he lost the exception.

Note: Governmental 457(b) plans are not subject to the 10% early-distribution penalty. This makes them more flexible if participants need access to their money before age 59½.

Important: If the participant rolled money into their 457(b) from another type of plan (such as a 401(k), 403(b), or IRA), those rolled-over amounts keep their original rules. Distributions of those funds before age 59½ may still trigger the 10% penalty unless the participant qualifies for an exception.

Takeaways: If considering taking distributions before the age of 59½, talk with a tax advisor to:

• Confirm if you qualify for an exception.
• Check whether that exception applies to both your 401(k) and an IRA.
• Decide if rolling over will help or hurt your qualification for an exception.

Tip: Rolling over might cause you to lose one type of 401(k) exception. However, it might allow you to qualify for an IRA-only exception. An example is the first-time homebuyer exception, which applies only to IRAs and allows up to $10,000 to be taken out penalty-free to buy or build a first home.

2. Do You Have Company Stock That Qualifies for Special Tax Treatment?

If you own company stock in your 401(k), you may be eligible for a special tax break called the “net unrealized appreciation” strategy. This allows you to pay the lower long-term capital gains tax rate instead of your ordinary income tax rate on the in-plan growth (appreciation) of those shares.

To qualify, you generally need to take a lump-sum distribution of your entire 401(k) in one tax year, and only after one of these events:

• Reaching age 59½.
• Separating from service with the employer.
• Being disabled.

If you roll your company stock into an IRA, you lose this special treatment. Withdrawals will then be taxed as ordinary income, which could significantly increase the amount of income tax owed.

Takeaways:

• Talk to your financial advisor before rolling over if your 401(k) balance includes company stock.
• Ask how to preserve eligibility for the NUA tax break.
• Carefully review your timing. This is often a one-time opportunity.

3. Do You Want to Delay Required Minimum Distributions Past Age 73?

Required minimum distributions are mandatory withdrawals the IRS requires from certain retirement accounts once you reach a certain age.

If you are still working, your 401(k) plan may allow you to delay your first RMD past age 73 until after you retire. This is commonly referred to as the “still-working exception.”

IRAs work differently. With an IRA, you must begin taking RMDs at age 73 (or earlier if you turned 73 before 2023), even if you are still working.

This means that rolling your 401(k) into an IRA while you are still employed could force you to start RMDs sooner than you would otherwise need to. Of course, your advisor might determine that it is tax-efficient to take distributions even before you are subject to RMDs.

Takeaways:

• Check if your 401(k) plan allows you to defer RMDs.
• Consider keeping your money in the 401(k) until you retire to take advantage of the deferral.
• Talk to your advisor before rolling over to avoid triggering earlier RMDs unnecessarily.

4. Will You Still Have the Creditor Protection You Need After a Rollover?

One benefit of a 401(k) is strong legal protection. Money in a 401(k) is protected from bankruptcy and most creditors under federal law.

IRAs offer protection, too, but the rules vary:

• Bankruptcy protection: IRAs are protected up to about $1.7 million (adjusted for inflation), with no cap on amounts rolled over from a 401(k).
• Other creditor protection: This depends on your state’s laws, which can vary widely.

Takeaways:

• If you are concerned about lawsuits or creditors, review your state’s IRA protection rules.
• Talk to an attorney to understand your level of protection after a rollover.
• Do not assume IRA protections are identical to 401(k) protections.

5. Have You Compared the Fees and Investment Choices on Both Sides?

Before rolling over, look at the costs of staying in your 401(k) versus moving to an IRA.

• 401(k) plans: Often have low institutional pricing and may include advisory services or planning tools at little or no extra cost.
• IRAs: May include annual account fees, trading commissions, or management fees if you work with an advisor.

Cost is only part of the picture. IRAs typically offer many more investment choices than most 401(k)s. That flexibility can be valuable if you are comfortable making investment decisions.

Takeaways:

• Compare both costs and features before deciding.
• A 401(k) might be better if it offers very low costs and solid investment options.
• An IRA might be better if you want more flexibility and are ready to make investment choices or work with an advisor.

To Roll or Not to Roll?

Rolling over your 401(k) to an IRA can be a smart move, but it is not always the right move. The key is to understand what you might gain or lose.

In some cases, you may even consider rolling money back into a 401(k), which could allow you to delay RMDs if your current plan permits it.

When in doubt:

• Ask questions.
• Run the numbers.
• Get advice from a trusted professional.

Your retirement savings are too important to move without a plan.