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Roll Over 401(k) to IRA But Keep Your Job

If your employer offers a 401(k) or other retirement plan, contributing to that plan is a foundation of your retirement savings. However, as you approach retirement age, you might consider moving some of your retirement funds out of your employer’s plan and into an IRA at a custodian like TD Ameritrade or Fidelity.

Such a rollover is often done when you leave an employer, though many employers give you the option of keeping your retirement account with them. What isn’t popularly understood, however, is that you also can do a rollover while you’re still employed, as long as you are over 59 ½.

One reason to consider leaving your employer’s plan is that most of them have higher overall fees than an IRA, especially if you choose from low-cost index mutual funds or exchange traded funds from a company like Vanguard or Dimensional Fund Advisors. It’s not uncommon to save up to 1% annually by making a rollover into these mutual funds.

However, the costs of an IRA are not always cheaper. If you have a Thrift Savings Plan (TSP) through the federal government, the total costs are .03% a year. This is far cheaper than the average equity fund that charges 1.3% or even Vanguard and DFA that charge .09% on some funds.

The disadvantage with a TSP, like most employer plans, is their very limited investment options. The TSP offers about six options. Most 401(k)s will offer several times that—still a pittance compared with the 13,000 available at most discount brokers.

Another reason for a rollover is what happens when you retire and need to withdraw funds from your account. You can withdraw money from an IRA at any time without penalty after age 59 ½, but withdrawing money from a past employer’s 401(k) plan will require jumping through a few more hoops.

One issue that surprises most people is that the required minimum distributions (RMD) rules are reversed for employer plans. A RMD is never required with a Roth IRA. However, a RMD must be taken from a Roth 401(k) when you turn 70 ½. For this reason I recommend you roll over a Roth 401(k) before you turn 70 ½. The flip side of this is that when you turn 70 ½ you do have to take RMDs from a traditional IRA, but you do not from a traditional 401(k), as long as you are working and own less than 5% of the company. Only a committee could have made up these rules.

The new tax code has made charitable giving less tax advantageous. However, if you are over 70 ½, you can give to charity tax-free from your IRA via a qualified charitable distribution (QCD). Employer plans don’t allow QCDs.

Another advantage of IRAs is that you can consolidate a number of employer accounts into one IRA. You can also withdraw funds from an IRA at any age without penalty for college expenses, which you cannot do from an employer plan.

Another big advantage to an IRA is the ability to do Roth conversions, which cannot be done with an employer’s plan. It’s especially important to do such conversions before turning 70 ½ when your RMDs and Social Security benefits (assuming you wait until 70) kick in and raise your taxable income and possibly your tax bracket. Taking advantage of lower tax brackets prior to age 70 to convert part of traditional IRAs to Roths can lower your RMDs, which lower your tax liability, and let some of your retirement funds grow tax free forever.

Done properly, a rollover from an employer’s plan to an IRA is free of any tax consequences. However, it’s important to evaluate the advantages and disadvantages carefully before you act.

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2 Responses to Roll Over 401(k) to IRA But Keep Your Job

  1. Charles Koch November 15, 2018 at 10:13 am #

    Three other tax preparers and myself have coffee each morning. We discussed paragraph that begins “One issue that surprises most people”. All agree this information is not correct. I can see nowhere on the IRS web site that it says a 401k Roth IRA must have RMD at 70 1/2. Also nowhere does it say 401k IRA does not require RMD at 70 1/2. Its does say just the opposite. Would like this explained.

    • Rick Kahler November 19, 2018 at 12:16 pm #

      Charles, thanks for your note.

      Maybe the confusion is in the term “401k IRA”. I did not use this term in the column as there is no such account, unless the reference is being used to indicate a rollover.

      In this paragraph, I was not referring to a roll over to an IRA from a 401k, but an existing 401k that still resides with an employer where the taxpayer is employed.

      Here is a piece from Kiplinger that confirms a Roth 401k must distribute a RMD once the taxpayer turns 70 1/2. https://www.kiplinger.com/article/retirement/T001-C001-S003-delaying-required-minimum-distributions.html.

      Also, if you are working and own less than 5% of the company (I did add this additional clarification to the piece) you do not have to take an RMD from your 401k. https://www.bankrate.com/retirement/401k-required-minimum-distribution-rules/

      I don’t know why the IRS says otherwise. We run into these rules often and this is how they are enforced by HR departments, investment companies, and reported on by the financial press.

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