Rolling over a 401(k) account

Steve Merrell |

Q: I have money in a 401(k) plan with my previous employer and I’m trying to decide what to do with it. Should I roll it into my new employer’s plan or into an IRA? If an IRA is better, should I roll it into a regular IRA or a Roth IRA? I have been trying to figure this out, but I am so confused. Help!

A: Deciding what to do with your 401(k) plan when you change jobs can be very confusing which is probably why a lot of people don’t do anything. According to the National Registry of Unclaimed Retirement Benefits, Americans “lose” billions of dollars every year as they switch employers. Here are some things you probably want to consider as you switch jobs.

When you leave a job, what happens to your 401(k) depends on the size of your account. If you have more than $5,000 in your account, the account will stay open until you decide to do something with it. However, if the account is worth less than $5,000 and you don’t do anything, the plan sponsor will usually roll it into an IRA for you. If the account is worth less than $1,000, the plan sponsor will usually close your account and send a check to your last known address. It will be up to you to deal with the tax consequences.

Leaving your money in a former employer’s plan can sometimes make sense especially if that plan offers a better selection of funds, charges lower expenses, or provides other benefits like access to financial planning resources. You can learn all about a particular 401(k) plan by carefully reading the Summary Plan Description. If you don’t have one, ask the plan’s administrator for a copy. If you decide to stay with the old plan, let the administrator know you are making an intentional decision to stay.

If you decide to take money out of your previous employer’s plan, you then face the choice of rolling your account into an IRA or into your new employer’s plan. Both options have benefits.

IRAs are more flexible than 401(k) plans and allow a much broader array of investments. While 401(k) plans are usually limited to mutual funds, exchange-traded funds and similar products, IRAs can invest in a variety of assets including things such as mutual funds, exchange traded funds, individual securities, and real estate.

The flexibility of IRAs is also a potential problem. If you venture away from publicly-traded securities, you must be careful not to run afoul of arcane IRS rules about permitted transactions. Violate those rules and you could end up owing significant taxes and penalties. If you decide to go with the IRA, I encourage you to work with an experienced and reputable financial advisor. An advisor will help keep you out of trouble and can design a portfolio that meets your return objectives without undue risk.

A benefit of most 401(k) plans over IRAs is the ability to borrow from your 401(k) account. I don’t often recommend borrowing from a 401(k) plan, but it can be helpful in emergencies or if you need money for a down payment or some other important purpose. You cannot borrow from an IRA. While there are hardship and first-time homebuyer waivers available for IRAs, those withdrawals are still considered taxable. The waiver simply means you do not have to pay the 10 percent early withdrawal penalty.

If you choose to roll your 401(k) balance into an IRA, you must then decide whether to roll into a traditional IRA or convert your rollover into a Roth IRA. A traditional IRA gives you a tax benefit at the time you make the contribution in exchange for paying taxes later when you take distributions from the account. With a Roth, on the other hand, you pay taxes now and never have to pay taxes on the distributions later.

The choice between a traditional IRA and a Roth IRA is primarily based on how you expect your future tax rate will compare with your current tax rate. If you think your tax rate will be higher when you take withdrawals in the future, you should opt for the Roth and pay your taxes now. However, if you expect your tax rate will be lower in the future than it is today, you should choose a traditional IRA and push your tax liability into the future.



Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to