When it comes time to rollover your employer 401(k), what are your best options? Most think the best solution is to rollover your plan to an IRA. Here are six options to evaluate before making a decision. These are available to plans with employees – not all options will apply to sole proprietor plans. Most options will not apply to SEP and SIMPLE plan participants.
1. Rollover to an IRA. There are a lot of benefits to this option. Rolling over to an IRA is a tax-free transaction when a direct rollover is used to move the funds. IRAs have more investment choices and are more flexible when it comes to distributions and financial planning. You generally get better service from your advisors than you will get from the 800 number for the plan.
2. Leave the funds in the company plan. You don’t have to do anything to accomplish this. The plan may hold life insurance that you cannot replace. An employer plan has greater creditor protection. If you are still working you may be able to delay required minimum distributions (RMDs). If you separate from service in the year you turn age 55 or later there is no 10% early distribution penalty on distributions made before age 59 ½. The age is reduced to 50 for federal, state or local public safety employees.
3. Roll your plan funds to the plan of a new employer. The benefits of this option are the same as in option 2.
4. A Lump-Sum Distribution. Take a total taxable distribution of all the plan funds. This option is beneficial when you need the funds for immediate financial needs such as foreclosure, eviction or medical expenses. If a plan holds highly appreciated shares of stock in the company that employs you, net unrealized appreciation (NUA) can provide significant tax benefits for some individuals. Two much less common tax benefits are 10-year averaging and 20% capital gain treatment (the plan participant must have been born before 1936 to qualify).
5. Roth IRA Conversion. All employer plan funds can be converted directly to a Roth IRA. If there are any after-tax funds in the plan, they can be converted – tax free – to a Roth IRA. The conversion will be taxable and it is an irrevocable transaction. Gains in the Roth IRA will be tax free when distributed as a qualified distribution. There are no RMDs during the Roth owner’s lifetime.
6. In-Plan Roth Conversions. Funds in an employer plan can be converted to a Roth account if the plan offers a Roth feature and offers in-plan Roth conversions. The benefits of this option are the same as in option 5 except that there are RMDs from a plan Roth once the plan participant reaches age 70 ½ (unless there is a still-working exception in the plan).