Rolling over your 401(k) to an IRA may seem appealing if you're leaving a job or you like the idea of having all of your retirement funds in one place. There are times when this is the smart move, but there are also times where you're better off leaving your money where it is. Here are three questions you should ask yourself in order to determine whether rolling over your 401(k) is a good idea.
1. Do you plan to retire early or late?
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Typically, you cannot withdraw your retirement savings before age 59 1/2 or you'll pay a 10% early withdrawal penalty. But there is an exception for your current 401(k). Under the Rule of 55, you can begin taking penalty-free withdrawals from your current 401(k) if you leave your job or are laid off at any time in or after the year you turn 55. This means that if you plan to retire before 59 1/2, you're better off leaving your 401(k) where it is so you can take advantage of this exception. The catch is, the Rule of 55 only applies to the 401(k) you have with your most recent employer. You'll have to wait until 59 1/2 to touch any older 401(k)s and IRAs without penalty.
You're also better off leaving your 401(k) where it is if you plan to retire after age 70 1/2. The government mandates that everyone begin taking required minimum distributions (RMDs) from all of their retirement accounts (except Roth IRAs) at this age. This may force you to withdraw more money than you'd wanted to, depleting your retirement savings more quickly. But there's an exception to the RMD rule if you continue to work. As long as you don't own more than 5% of the company that you work for, you can delay taking your RMDs until the year that you retire. This means you can withdraw only as much as you actually need and your existing savings can continue to compound -- but it only works for 401(k)s, not IRAs.
2. What kind of fees does your 401(k) charge?
All retirement accounts charge some fees to cover record-keeping and other administrative costs. Investment products also have their own fees, which are usually charged as a percentage of your assets. Typically, 401(k) fees are higher than IRA fees, especially with smaller companies that have fewer employees to spread these costs among.
Rolling over your 401(k) to an IRA could be a smart choice if you're paying more than 1% of your assets in fees every year. You can figure out how much you're paying in fees by checking your 401(k) plan summary or the prospectus for your investments. But if your 401(k) fees are less than 1% of your assets or your employer matches some of your contributions, it may be to your benefit to leave your money where it is. Your savings may be able to grow more quickly with employer-matched funds than they would in an IRA, even if the IRA fees are lower.
3. Do you have company stock in your 401(k)?
If you have company stock in your 401(k) and you decide you'd like to roll over that account to an IRA, you have two choices. You can roll over all of the assets, including the company stock, into your IRA, or you can roll over all of the assets except the company stock and transfer the company stock to a taxable brokerage account. At first glance, the second option may not seem like a smart one because you'll have to pay income taxes on the company stock and a 10% early withdrawal penalty if you take money out while you're under 59 1/2. But it may still be worth it for some.
When you move your company stock out of your 401(k) to a taxable brokerage account, you only have to pay taxes on what you initially paid for the stock, not on its current market value. If the stock has appreciated significantly since you bought it, this may save you money compared to transferring the stock to an IRA and paying income tax on the full amount when you withdraw it.
When you sell the company stock that you transferred to a taxable brokerage account, you only have to pay capital gains tax on the stock's net unrealized appreciation. Short-term capital gains for assets you've had less than a year are taxed at your income tax rate. Long-term capital gains tax rates are used for assets you've held longer than a year, and they're usually lower than income tax rates, maxing out at 20%. Income tax brackets go as high as 37%. Depending on your income and tax filing status, you may not have to pay any long-term capital gains tax on your company stock at all, and this could save you a lot of money compared to transferring that stock to an IRA. Here's a more detailed article to help you determine how much you could owe in taxes on your long-term capital gains if you cash out in 2019.
It's up to you to decide whether a 401(k) rollover is a smart choice or not. The answer will probably be different with every 401(k) at every job. Consider the costs of the 401(k), your investments, and your long-term goals and let this information guide your decision.
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