Roll Your 401(k) into an IRA Only After Knowing the Advantages of Each
© Shane Flait (2012)

You may consider rolling over your company’s 401(k) plan into an IRA when you retire. Before you do, consider the advantages of each as outlined below in this article.

Advantages with an IRA

Early-retirement: If you’re considering early retirement, you can withdraw funds from your IRA before 59½ without the 10% penalty under the "substantially equal periodic payments rule[1]." But you must withdraw a specific amount each year using an IRS-approved calculation method. And you must maintain such withdrawals (or distributions) for five years or until you reach 59½ - whichever is longer!

On the other hand 401(k) plan participants face a 10% penalty if they withdraw funds before they are 59½.

Options for beneficiaries: With recent legislation, both spouse and nonspouse beneficiaries of a 401(k) have equivalent options, because the 401(k) beneficiary can now transfer money to an IRA.

Other Penalty–free withdrawal options: An IRA allows penalty-free withdrawals for higher-education expenses and first-time home- buying, which 401(k) plans and other employer retirement plans don't necessarily offer.

More investment options: IRA owners can have multiple IRA accounts with different investment objectives and can take withdrawals from any of the accounts. Each can have its own beneficiary. Though 401(k) plans may offer a broad range of investment options, the choices generally are limited to one account.

More flexibility in paying fees: Asset management fees levied by your IRA custodian must disclose all fees when the account is opened or when the fee schedule changes. And, as an IRA owner, you can pay the asset management fee out of the IRA account or with funds from a non-retirement account. The latter can used as an itemized tax deduction on your yearly income tax form – Schedule A.

On the other hand, employers pay 401(k) plan administrative fees. If you as a participant are invested in various funds, those fees generally come out at the fund level and largely are buried.

Advantageous unique to your 401(k)

Reduced taxation on company stock: If you hold company stock that’s appreciated significantly, you can pull it out as a lump sum and pay tax on the price you paid for it – not its appreciated value. You can hold that stock; and whenever you sell, you’ll only pay low (15%) capital gains tax on the appreciation. Transferring that stock to an IRA would lose that tax break and subject it to normal income tax.

Early Retirement: Plan participants can withdraw money directly from the plan without penalty if they leave the company after reaching 55. This rule doesn’t apply to IRAs.

So before you make any transfer, determine when you wish to retire and how you plan to use your qualified plan money. Then choose whether you your better off transferring your 401K to an IRA or leaving it where it is.  

Refer to the table as a summary.

 

Comparative Advantages of IRAs and 401(k)s
Issue	IRA Advantages	401(k) Advantages
Early-retirement options	Can take out  before 59 1/2 without penalty under 'substantially equal periodic payments rule'	You can withdraw money from plan for early retirement with no penalty if leave company after 55 years old
Options for beneficiaries	Similar options now	Similar options now
Penalty-free withdrawals options	For higher education expenses, and first-time home buying	Maybe unavailable
Investment choice options	Can establish multiple IRAs for different investments and different named beneficiaries for each account	Single account - not as much investment choices as IRA
Flexibility in Paying fees	IRA custodian must disclose all fees when account is opened.  You can pay fees out of IRA, or separately for itemized tax-deduction.	Employers pay administration fees. If invested in some funds, these fees are largely buried to employee.
Reducing Capital gains	Everything withdrawn is subject to your income tax rate	You can pull out company stock separately and pay tax only for unappreciated price you paid for it.  You can hold it or when sell you'll be taxed at 15% capital gains rate on the Net Unrealized Appreciation

 

 

 

 

 

Shane Flait is a writer and educator. See more at www.EasyRetirementKnowHow.com