7 Reasons NOT To Roll Your Retirement Plan into an IRA

Do you have a retirement plan from a former employer? Last week, I received two separate questions about what to do with a 401(k) from a previous job. Both times the person asking the question was thinking about moving it and both times they decided to leave it where it is after reviewing the pros and cons.

We’re often inundated with messages from financial service companies and their representatives to roll over those plans into an IRA and in some cases, that might make the most sense. After all, you may have better investment options in an IRA, have an advisor that you want to have manage it, or just prefer to consolidate multiple accounts. However, there’s not enough attention paid to some of the reasons you could be better off leaving it where it is. Here are some of them:

1)      Low or no cost investment advice. Many retirement plan providers offer investment advice to plan participants that you can continue to utilize after you’ve left the job at no additional cost. Some advice programs like Financial Engines can also advise on money outside your retirement plan.  Even when there is a fee, it’s often less than what you would pay for an outside adviser.

2)      Better investment options. Your plan may also offer unique investment opportunities that you can’t purchase outside the plan. As an example, one of our clients’ plans includes mutual funds  that use hedge-fund like strategies and investment vehicles that non-accredited investors don’t generally have access to. More commonly, your plan may offer a stable value fund, a low-risk type of fund that’s available only in qualified plans and pays much higher interest than most other low-risk options like money market funds.

3)      Lower fees. In large retirement plans, you can typically buy institutional shares of mutual funds that have lower fees than if you purchased the same fund outside the plan. This shouldn’t be overlooked considering that low fees are one of the best indicators of superior future performance.

4)      Stronger creditor protection. Under federal law, qualified plans like 401(k)s are generally protected from bankruptcy and other creditor lawsuits except tax liens imposed by the IRS (you knew they’d exempt themselves, didn’t you?). However, IRAs are only protected from bankruptcy up to $1 million and other creditor judgments vary from state to state. This could be important if you’re worried about being sued.

5)      Lower taxes on company stock. If you have company stock in your plan that has gone up in value, you may not want to roll it into an IRA. That’s because if you transfer the stock directly into a brokerage account instead, you can pay a tax on the earnings at a capital gains rate rather than the higher income tax you’d pay on withdrawing the money from an IRA. (Either way, you could still be subject to  a 10% penalty if you make an early withdrawal.)

6)      Earlier access. Speaking of early withdrawal penalties, with an IRA you have to wait until age 59 ½ to avoid the penalty, but with a 401(k) or 403(b), you can make penalty-free withdrawals earlier as long as you’ve worked at that job until the year you turn 55. So if you’re retiring within that 4 ½ year gap, think twice about rolling your 401(k) before age 59 ½. A 457 plan is even better since there are no early-withdrawal penalties at all.

7)      Flexibility. If you leave your account where it is, you can always roll it into an IRA later. For instance, someday you may want to use some of your 401(k) money for a first-time home purchase or education expenses, which are penalty-free from an IRA but not a 401(k). However, once you roll that money out, you generally can’t roll it back after you leave the company.

If you haven’t heard of some of these, it may be because the financial services industry makes a lot of money convincing people to roll money into an IRA with them. So the next time you hear an advertisement or a financial advisor asking you to roll your money into an IRA, ask yourself a question. Is  it really in your best interest or just theirs?

 

 

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