Why a 401(k) Rollover Might Be the Right Move — Or Might Not

Rolling over a 401(k) from a previous job is always an option. But is it the right one for you? Here's when it may make sense, and when it may not.

The Case for Rolling Over

One of the main advantages of rolling over into an IRA is the expanded investment options. Inside an IRA you can invest in individual stocks, bonds, ETFs, and alternative assets, giving you far more flexibility to pursue growth than most 401(k) plans allow. Many 401(k)'s default to target date funds, which are designed to de-risk as you approach retirement. If you have a longer time horizon or want more control over your growth strategy, an IRA gives you that.

If you've changed jobs a few times, you may have multiple old 401(k)'s sitting on autopilot. Rolling them into a single IRA simplifies your financial picture and makes it easier to ensure your overall investment strategy is aligned with your goals.

An IRA also generally offers more flexibility over beneficiary designations and inheritance options than most employer plans.

Working with an advisor becomes easier too. Old 401(k)'s are often difficult to access — getting questions answered or making adjustments can be a slow process. An IRA managed by your advisor keeps everything visible and responsive.

If needed in a financial emergency, you do have the option to cashout as well.  If having the cash now outweighs the long-term costs of your situation, then you have access to these funds. 

Finally, an IRA may carry lower overall costs. 401(k)'s can layer administrative fees on top of fund expenses. A well-constructed IRA using low-cost ETFs can meaningfully reduce that drag over time.

The Case for Keeping Your 401(k)

401(k) plans carry strong federal ERISA protections from creditors. IRA protections vary by state, Oregon's are relatively strong, but they are not unlimited. For some people, that distinction matters.

Many people aren't aware of the Rule of 55. If you leave a job at age 55 or older, you may be able to take penalty-free withdrawals from that employer's 401(k), no waiting until 59½. Roll it to an IRA, and that option disappears.

If you are 73 or older and still working, you can delay required minimum distributions (RMDs) on your current employer's 401(k). A Traditional IRA does not offer that same deferral.

If you hold highly appreciated company stock inside your 401(k), rolling over could cost you a significant tax advantage. A strategy called Net Unrealized Appreciation (NUA), if you qualify, allows you to pay ordinary income tax only on the original cost basis of the stock, while the appreciation is taxed at the lower long-term capital gains rate. Roll those shares into an IRA, and that treatment is gone permanently. For someone sitting on a large, appreciated position, this is worth a serious conversation before any decision is made.

If you do decide that cashing out your 401(k) is what you would like to do, there are some things that need to be considered.  The distribution is taxed at ordinary income, and if you are under 59 ½ years old, there is an additional withdrawal penalty on top of your taxes. 

In addition to the immediate hit to the account balance, where you can really lose out is the years of compounding.  Depending on your age, this could lead to a significant loss in the long-term.

Lastly, 401(k)'s offer a loan provision that IRAs do not. For some people, that access matters.

The Bottom Line

A rollover isn't automatically the right answer just because you left a job. The right move depends on your age, your other assets, your plans, and what you're trying to accomplish. The question isn't just can you roll it over, it's should you, and when.

If you're not sure, that's exactly the kind of conversation worth having before you make a move you can't undo.

A plan participant leaving an employer typically has four options (and may engage in a combination of these options): 1. Leave the money in their former employer’s plan, if permitted; 2. Roll over the assets to their new employer’s plan, if one is available and rollovers are permitted; 3. Roll over to an IRA; or 4. Cash out the account value.

Tallus Capital Management and LPL Financial do not provide legal advice or tax services. Please consult your legal advisor or tax advisor regarding your specific situation. 

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. The principal value of a target fund is not guaranteed at any time, including at the target date.