Rolling a 401(k) into an IRA? Six Questions to Ask First.

Feb. 10, 2014
 Rolling a 401(K) into an IRA? Ask 6 questions first.
 By Joe Lucey 
Since the creation of the 401(k) and other employer-sponsored retirement plans, most advisers and investors have focused on how to get money into them — not necessarily how to best take money out of them.
 Now, with baby boomers entering their retirement years at a rate of over 10,000 a day, investors have to change their focus from accumulation of assets to generating a lifetime of income from these assets.

Typically, once your employment ends, you have four options for your company-sponsored retirement assets:

1) Leave the money in your former employer's plan;
2) Roll the funds into a new employer's plan (assuming you continue to work);
3) Transfer the assets into an IRA account; or
4) Cash out the balance, paying the applicable taxes and penalties (which depend on your age and circumstances).

 Whether you are transitioning to a new employer or retiring from the workforce, you'll want to avoid some very common — and irreversible — mistakes. Fortunately, by asking a few key questions, you can make well-informed decisions, analyze trade-offs and avoid surprises.

Here are some critical questions to consider:

When will I need income? 

Upon leaving a company at age 55 or older, a former employee can take penalty-free withdrawals from their company-sponsored 401(k) account. However, if that 401(k) is rolled into an IRA, the penalty-free withdrawal age increases to 591/2. (One notable exception is public-service employee plans, such as those for firefighters, police officers or emergency medical personnel, which may allow penalty-free withdrawals as early as age 50 if left in their employer plan.)
There is well-documented loophole regarding early withdrawal penalties, based on the 72(t) Substantially Equally Periodic Payments. Essentially, the IRS approved several methods of calculating withdrawals from an IRA before age 591/2; these can sidestep the 10% penalty — but if you plan to take this route, use caution. Once a 72(t) payment plan is established, it locks you in for a minimum of five years or until age 59 1/2, whichever is longer. Your IRA cannot be modified or changed during the payment period (except in case of death); failure to follow every strict rule of this strategy results in some very ugly tax consequences.
A superior option may be to leave some assets in your former employer's 401(k) plan, before completing a rollover, if income will be needed before age 591/2. For example, perhaps you have a million-dollar 401(k), and you plan to take withdrawals totaling $200,000 in the first three years of retirement. Keep $200,000 in the 401(k) and roll the remaining $800,000 into your IRA.
Because employer plans can vary, it is important to discuss your strategy with the company plan administrator to ensure you're complying with the rules of that specific 401(k).

 What are my fees and investment options?

 Rolling your 401(k) into an IRA can reduce your management fees and provide more investment options, but if price was the only factor to consider, everyone would be driving a Kia. It is important to know what you're paying for and feel comfortable with the value provided.
In addition, the Financial Industry Regulatory Authority, or Finra, recently issued a regulatory notice, warning firms against overselling clients on the strategy of shifting retirement dollars from 401(k)s to IRAs when they retire or change jobs. Whether you leave your 401(k) where it is or you move it into an IRA, make sure that you're assessing which retirement plan will serve you best.

Does my career put me at risk of being sued?

 Company-sponsored plans generally provide greater protection from lawsuits than IRAs. If you are a physician, own a construction company, or work in any field with heavy liability issues, you may be at higher risk for a lawsuit down the road. In that case, it might be wise to consider keeping your 401(k) where it is.

Have I made nondeductible, after-tax contributions to the plan? 

 Often, participants make contributions to their 401(k) that weren't deducted from their annual income (in the year of the contribution). Check with your plan administrator to ensure that these contributions are separated from the remaining retirement funds and not commingled with other IRA assets. Failure to do so would require you to file an additional IRS form (8606) with your annual tax return to protect what should be tax-free withdrawals of those contributions.

Do I own company stock in the plan?

 If your 401(k) includes company stock, explore the advantages of Net Unrealized Appreciation (NUA). This allows a participant to withdraw the company stock "in-kind," thereby removing it from your retirement account. The cost basis of the stock will be recognized as income in the year of the withdrawal, but NUA can substantially reduce future taxation (when required distributions force their liquidation) and ensure the most optimal taxation of these assets.
Just like plumbing and electrical work, some things are best left to a professional. This is certainly true with NUAs, so let the pro's take over. Discuss this strategy with a competent financial or tax adviser — before its implementation — or you could put yourself at risk for some unfortunate mistakes.

 Who does my adviser work for and what are they qualified to do?

 Your retirement accounts represent years of sacrifices. Contributions meant fewer dollars to spend on family vacations, dining out, new cars and homes. You made a conscience decision to sacrifice certain things today so you would have more security tomorrow. Now that tomorrow is fast approaching, you want to make sure you get the most from your assets.
Developing a savvy strategy to pull money out your retirement accounts — without paying any more in taxes and penalties than is absolutely necessary - depends on the guidance of an adviser who adheres to a high fiduciary standard, and has the credentials and expertise to turn your years of sacrifice into a lifetime of financial security.
That strategy begins with the answers to these questions. So know your options and issues before you roll your 401(k) anywhere, and position yourself to preserve and maximize every single dollar you've saved.