Like many questions about finances the answer is, it depends. So, let’s talk through some things to consider when deciding what to do with your 401k.
Fees:
There are typically two types of fees you will want to consider when you have money invested in an employer sponsored retirement plan. The first is administrative fees. These are generally monthly or annual fees that are passed on from the plan administrator to the plan participants. Usually these fees are relatively low, often less than $20 per year, however sometimes these can be as high as $200 per year or more. If that’s the case I like to think about it in terms of a percentage of the account. If you have a small balance account, then those fees may really eat into your performance.
The other type of fee to consider are the Expense Ratios of the funds available in your plan. Because the 401k is an institutional account, you may have access to institutional class shares. Think of it like the 401k is the customer and because they are buying in bulk they get a discount from the mutual fund company. It’s sort of like getting your groceries from Costco.
With that said, there are many mutual fund and ETF companies that offer comparable investments at extremely low fees or even zero expense ratios on their funds so we often look at this type of expense as a non-issue when evaluating your options.
Investment Options:
Most 401k plans offer a limited menu of funds available within the plan. This menu could have 10-50 different mutual funds available. For some that can seem like a lot of choice, but the universe of investment options for mutual funds alone is well over 5,000, so in comparison the 401k menu may seem quite limited.
There are many plans that will offer a link to a brokerage account under the umbrella of the 401k plan that enable you to access a significantly expanded menu of Mutual Funds, ETFs, and even individual stocks. Usually these offerings come from the big discount brokerage firms like Fidelity, Schwab, and TD Ameritrade. If your 401k is housed at one of those brokerage firms you may well have access to more options.
For individuals looking to pass on the management of their funds to a professional you may have a hard time leaving the funds in the plan as many will not allow your Advisory firm the ability to manage the plan which often requires a rollover.
A popular investment option for conservative investors is what’s known as a stable value, this is one option that is important to review as it acts similar to cash, but often pays a much higher interest rate than what you can find on bank accounts or even short term CDs.
Employer Stock:
If you’ve been purchasing employer stock in your 401k, or did a long time ago and have shares that increased significantly in value, you may want to explore something called Net Unrealized Appreciation before you decide to take any money out of your 401k.
What is Net Unrealized Appreciation? It’s a tax rule that allows you to move some or all of the value of your employer stock out of your 401k and into your investment account. In doing so you will pay income taxes only on the cost basis of the stock and when you decide to sell the stock at some point in the future you will only pay taxes on the gains that you realize.
This strategy can do several things for you, if you are in a tax bracket over 15% in retirement you will likely benefit from much lower capital gains tax rates. Additionally you will reduce the account balance in the 401k which means lower Required Minimum Distributions when you turn 72. Lastly, it could give you access to the money earlier than you would otherwise be able to access it due to early withdrawal penalties on a 401k if you retire before 59.5.
It doesn’t always make sense though, for example, you may find that you can withdraw funds from your 401k and still be in the 12% tax bracket for your Federal income tax. This would of course be more favorable than the 15% capital gains tax bracket that you may find yourself in. Lastly, if you do have a significant amount of company stock in your 401k you may want to diversify that position to reduce risk especially as you are approaching retirement. Utilizing NUA means you will pay taxes on all of your gains whereas selling within the 401k means no taxes on the gains, only the amount of money you withdraw.
Vesting:
If you have not fully vested in your plan and there’s a chance you could go back to work for the same employer in the future you may be able to jump back into your vesting schedule where you left off if you leave the funds in the 401k. If this is the case employers often won’t offer this benefit to you had you rolled the money out of the plan when you left the company. This is always going to be unique to your retirement plan, you should check with your HR department on this issue before rolling the funds over or deciding to leave them in the plan.
In most cases if you have company contributions and leave your employer you will be leaving your unvested matching contributions on the table, so if you are leaving your employer it’s worthwhile to double check your vesting schedule, if you’re close to another vesting date it may be worth it to hold off on starting the new job or leaving the company if you can.
Outstanding Loans:
It’s important to understand what your options are if you have an outstanding 401k loans as plans will treat this differently. Some plans will consider your loan a distribution after you leave the company, you’ll likely have a small window of time to repay this loan to avoid any early withdrawal penalties, but that’s not always the case. Some plans will allow you to continue making payments on the loan, but only if you maintain a minimum balance in the 401k as defined by the plan.
It’s very important that you check in with your 401k administrator or HR department to understand how your plan treats these before completing a rollover.
Protection from Creditors:
401k’s offer unlimited protection from creditors and bankruptcy whereas IRAs can be limited to $1.5M in protection. There are different types of IRAs however, a Traditional IRA and Roth IRA only offer roughly $1.5M in protection whereas SEP IRAs, SIMPLE IRAs, and Rollover IRAs will offer the same unlimited protection from creditors as a 401k.
Services:
This is an important one. Because all 401k plans are slightly unique they don’t all offer the same access to services. Some plans won’t allow you to take a systematic withdrawal which would make it difficult if you plan to pull money monthly as your retirement paycheck. Some plans may require a form or a phone call every time you want to make a withdrawal. Some plans will continue to offer you the ability to borrow and or pay off your loan over time even after you have separated from service while others may not offer these benefits when you are no longer with the company.
What if it’s an inherited 401K?
Many people will move the funds from an inherited 401k into an inherited IRA. Doing so will cause you to lose the ability to convert those funds to Roth as Inherited IRA funds can’t be converted. With the new rules about taking RMDs over a 10 year time frame if you were a non-spouse beneficiary, the ability to convert to Roth may be quite attractive depending on your tax situation.
As you can see, the decision to rollover or not to rollover can be a bit more complex depending on your unique situation. There are a lot of factors to consider so it’s important to have a solid understanding of your current and future financial needs in order to make this decision.
None of the information in this document should be considered as tax advice. You should consult your tax professional for information concerning your individual situation. Tax services are not offered through, nor supervised by, The Lincoln Investment Companies. Diversification does not guarantee a profit or protect against a loss.