Should I Rollover an Old 401(k) or Other Retirement Plan Account?
Although the Bureau of Labor Statistics doesn't specifically track career changes, we can reasonable expect that most individuals will change jobs multiple times over the course of their lifetime.
We see this trend especially with younger generations that value opportunity, mobility, and flexibility when it comes to pursuing meaningful work.
Because of this, we've begun to see a trend: orphaned 401(k)s and other retirement accounts. They are called such because they are lonely, neglected, and forgotten about.
This begs the question: what should I be doing with these accounts if I change jobs?
Disclosures:
For the purpose of this article an “employer sponsored retirement plan”, “retirement plan” , “retirement account”, or “retirement plan account” may be used interchangeably to reference 401(k)s, 403(b)s, 457s, and any other similar plan.
Also, please reference your specific retirement plan documents in order to verify the information specifically applicable to your situation.
What is a rollover?
A rollover is the process of moving an employer sponsored retirement plan from an existing provider to either a new provider, if allowed by the current plan, OR an outside IRA.
Option 1: Rolling over an old retirement plan account to a new retirement plan account
Rolling over an old retirement plan to a new retirement plan at a new provider could look like moving an old 401(k) over from your old employer to your new 401(k) at your new employer.
Not every retirement plan allows for inbound rollovers into their plan so you will have to check the specifics on if this is allowed.
Option 2: Rolling over an old retirement plan account to an IRA
Rolling over an old retirement plan to an outside IRA could look like moving an old Traditional 401(k) over to a Rollover Traditional IRA at an outside provider or even the same provider.
Note: Rollovers differ from transfers as transfers typically involve moving an IRA (Traditional or Roth) to another IRA at a different custodian. Also, the process tends to be very different.
Reasons to consider a rollover
Here are some reasons, but not all, that you MAY want to roll over an old retirement plan to either your new retirement plan or an IRA:
Note: In order to rollover an old retirement plan account to a new retirement plan, the new retirement plan must allow for incoming rollovers AND accept the type of money that you would be rolling in (i.e. pre-tax, after-tax, etc.).
Job change
Perhaps one of the biggest triggers for why individuals want to rollover old retirement plan is whenever they change jobs and more specifically leave their employer.
Contrary to popular belief, separation from service doesn’t automatically mean that you have to rollover an account within an old retirement plan. But rather the job change, i.e. separation from service, grants the participant the ability to rollover their account.
However, many individuals may want to separate entirely when leaving a job. “I’m not there anymore so why should my account be a part of their plan?”
You can choose to rollover your retirement plan account to a new retirement plan account (if allowed) or to an outside IRA.
Forced to
Coupled with a job change, many retirement plans require a forced distribution if the account is less than a specified amount such as $1,000 or even $5,000.
For example, a company can typically close your account and issue you a check if your account balance is less than $1,000. Or, if it’s more than $1,000 but less than $5,000 then they’ll prompt you to open an IRA in order to receive the funds.
When in doubt check your 401(k) plan summary document. This is a way that plan administrators reduce their administrative costs.
If you’re being forced out because your account balance isn’t high enough then you’re on the clock to find a destination for this account. Again, this timeline can be found in your plan summary document and they should notify of your timeline as well.
You can choose to rollover your retirement plan account to a new retirement plan account (if allowed) or to an outside IRA.
To simplify
If individuals are changing jobs even 3-5 times over their lifetime then you can see the burden of potentially having 3-5 different outstanding retirement plan accounts.
If you’re having trouble keeping tabs on all of your accounts, and how they’re invested, then it likely makes sense to simplify by consolidating them via a rollover.
When you simplify your finances as much as they can be, you can actually take better care of them.
You can choose to rollover your retirement plan account to a new retirement plan account (if allowed) or to an outside IRA.
Better investment options
Every employer sponsored retirement plan is going to have limitations when it comes to the investment options that they offer. Expect anywhere from 10-30 investment options to choose from.
Ideally, you’d have handful of broad market investment options in order to craft a well diversified portfolio. But many plans do not. Do your due diligence or hire a qualified professional in order to assist you.
If your old retirement plan doesn’t have equal or better options than your new retirement plan, or an outside IRA, then it could be in your best interest to consider rolling over your account.
You can choose to rollover your retirement plan account to a new retirement plan account (if allowed) or to an outside IRA.
Better features & retirement plan provisions (plan-to-plan)
It’s amazing how retirement plans continue to evolve and improve. Again, not all retirement plans are created equal.
However, it’s important to know the key features and provisions of each retirement plan in order to evaluate where the account should be.
Some important features that you might find in your new retirement plan that you might not find in your old plan:
In plan Roth conversions
A nice feature that some retirement plans offer is in plan Roth conversions. This simply allows you to convert pre-tax (Traditional) dollars, or even nondeductible non-Roth dollars (more on this), to after-tax (Roth) dollars.
Do note that this will trigger tax implications so be sure to check with your tax professional before making any moves. Any amount that is converted will be taxed as ordinary income for the year in which it’s converted.
However, this becomes increasingly important when managing and optimizing your personal tax situation. There are times when it makes sense to go ahead and pay tax today rather than wait until you need the funds in the future.
For example, maybe you’ve slid into a lower tax bracket recently due to some life circumstances and also anticipate a tax refund this year that can offset your taxes owed. This would be a great opportunity to convert some pre-tax money within your retirement account to your after-tax bucket.
Brokerage link
A brokerage link option allows a retirement plan participant to link their retirement plan account to a brokerage account under the same retirement plan and plan provider.
For example, I know that Fidelity offers a Brokerage Link option for their retirement plan platform. Again, not every employer will choose to have this feature added to their retirement plan so you’ll need to check.
The benefit of using a brokerage link option is access to a wider array of investment options. So for example, if your 401(k) plan has a poor pool of investments to choose from then you could use the brokerage link option to gain access to virtually any publicly traded investment.
This could save you money in the form of investment fund expenses (i.e. ability to choose cheaper investments) and it could allow to choose investment options that perform better than what you originally had available to you.
This option is best for DIY’ers and those working with an advisor. If not, investors can get lost in the sea of investment options, choose the wrong investments, and too easily act on emotions during market fluctuations.
Cheaper
Often times when you separate from service with a former employer they will pass on any administrative 401(k) fees to you. Again, not always so be sure to check your 401(k) plan summary document or compare 401(k) statements (checking the fee line) from pre-separation and post-separation.
Also, with a rollover there’s a potential opportunity to invest in cheaper investment funds within the new plan or an outside IRA.
Professional advice & service (plan-to-IRA)
Perhaps one of the best reason to rollover an old retirement plan account is to get access to professional advice and service while paying for it directly from your account. This is only a real option for those rolling over an old retirement plan account to an IRA that can be managed by a financial advisor.
Now this isn’t the best option for everyone but if you want access to financial advice then this could be an option to get it. Do note that you’d likely be paying for this advice in the form of fees deducted from your account.
“Price is what you pay. Value is what you get.”
When potentially evaluating an advisor be sure to start with those that are fee-only fiduciaries and those that will provide significant value over what you’re paying them.
On the flipside, there are many advisors out there serving their clients and charging them fees that can be paid monthly, quarterly, or annually and directly from their cash flow (i.e. checking account).
Interested? Many of our advisors at the KC Financial Advisors Network can do either for you. Also, you can also check out XY Planning Network for other advisors that may be able to serve you.
The important thing is you want to find an advisor that is going to provide valuable advice across your entire personal financial landscape.
Other rollover considerations
Everybody often thinks that the default is to always rollover an old retirement plan. However, it may not always be the best course of action. Here’s why:
Mega back door Roth conversions
A mega back door Roth is a strategy used to contribute funds into a retirement plan above the $19,500 annual limit through non-deductible non-Roth contributions AND converting those same contributions to the Roth bucket of your account.
Nondeductible non-Roth contributions
The elective deferral contribution limit for 401(k)s, 403(b)s, and 457s is capped at $19,500 for 2021. That includes combined contributions that are pre-tax (Traditional) or after-tax (Roth). There’s also a $6,500 catch up contribution that those over 50 are eligible to contribute each year.
If you’ve maxed out this limit, there may be an opportunity to contribute more to your plan. You’ll want to check to see if your plan allows for nondeductible non-Roth contributions. A mouthful I know.
In short, these contributions aren’t taxable, because they are made with after-tax dollars, BUT the gains and growth would be taxable as ordinary income whenever withdrawn from the account during retirement.
So why do this in the first place? I know it sounds exactly like a taxable account.
The advantage is in the conversion of these funds.
The conversion
If in-plan Roth conversions, mentioned above, AND nondeductible non-Roth contributions are allowed within a plan, then you can conduct a Mega Backdoor Roth conversion.
This is the process of converting nondeductible non-Roth money to your Roth bucket by circumventing the “normal limitations” (i.e. $19,500 annual limit). This is completely legal by the way.
Since the nondeductible non-Roth contributions wouldn’t be taxable either way you’re ultimately shielding the long-term growth on these specific contributions from being taxed in the future whenever withdrawn.
No taxes will need to be made either since you’ve already technically paid tax on the contributions.
When you separate service from an employer you can no longer contribute money to that specific retirement plan. However, it still may be beneficial to keep your account there in order to finish converting any nondeductible non-Roth money.
Also, converting nondeductible non-Roth money is better to do within a retirement plan than an IRA as to avoid the Pro Rata Rule.
Please review your retirement plan summary document for all specific provisions regarding your specific retirement plan.
Creditor protection
Let me first say that all retirement plans and accounts have some degree of protection against creditors and bankruptcy proceedings. Some just have more protection than others depending on what type of account you contributed the original money to AND the state you live in.
It’s important to realize that there’s two main creditor protections you need to be concerned with: bankruptcy and non-bankruptcy (i.e. attachment).
It’s also important to understand that no type of account will protect your assets from divorce proceedings (i.e. division of assets via QRDO), the IRS for federal income tax debt, the Federal Government for fines and penalties, or civil and criminal judgments.
ERISA accounts
The Employee Retirement Income Security Act (ERISA) of 1974 created protections, for retirement accounts, from creditors, bankruptcy proceedings, and civil lawsuits. Claims can’t even be filed for assets held in ERISA qualified accounts. This is what makes ERISA plans the gold standard of protection for your retirement assets.
Even funds transferred from an ERISA qualified account to a rollover IRA are fully protected.
As you can see, you have significant protection with funds held within an ERISA qualified account. Be sure to check if your plan/account is ERISA qualified. Retirement Plans CAN EXIST without being ERISA qualified.
Non-ERISA accounts
On the contrary, non-ERISA accounts don’t necessarily have the same degree of protection. The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005 was a piece of legislation that finally afforded certain retirement assets (i.e. IRAs) federal bankruptcy protection.
Per Investopedia on BAPCPA and IRA protections,
“Protection under BAPCPA varies, depending on the type of IRA. Traditional IRAs and Roth IRAs are currently protected to a value of $1,362,800, with adjustments for inflation made every three years (the next adjustment is in 2022). SEP IRAs, SIMPLE IRAs, and most rollover IRAs are fully protected from creditors in a bankruptcy, regardless of the dollar value.”
In short, while this provision affords IRAs more protection than they historically had you still want to make sure any ERISA qualified funds make it into a rollover IRA.
Thankfully, both Missouri and Kansas offer full protection for all IRAs in the event of non-bankruptcy scenarios. I’m guessing they want to keep the assets in state if possible for future tax revenue (i.e. income, estate, etc.).
¹ Source: https://revisor.mo.gov/main/OneSection.aspx?section=513.430
² Source: https://www.ksrevisor.org/statutes/chapters/ch60/060_023_0008.html
³ Source: https://www.investopedia.com/terms/b/bapcpa.asp
³ Amounts are adjusted every 3 years with the next adjustment occurring in 2022.
Do-It-Yourself
If you’re a DIY’er, then you’re likely more capable of managing your own investments. If this is the case then you could stand to benefit, from the various aforementioned reasons, to rollover your account to an existing plan or an outside IRA.
Conclusion
When it comes to your retirement plan accounts, you need to know all of your options so that you can evaluate what’s in your best interest.
Whether you decide to rollover an old retirement account or not, you need to have a plan and sound reasoning for your decision. Choosing the right option can set you and your finances up well for years to come.
If you’re struggling to figure out where to start then feel free to reach out to one of our KCFAN Advisors!
