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  • Christian Bishop CFP®, EA

To Rollover, or Not to Rollover?

There are lots of reasons to rollover a 401K, here are some reasons NOT to… 

When you have left an employer and have a 401K plan, the question of whether or not to roll over your balance in the plan to an IRA or a new employer plan often comes up. There are many factors to consider prior to making the decision. Given that the decision to rollover a plan is final, careful thought about doing so is important. There are reasons for rolling over your 401K, or other company provided retirement plan, that may benefit you. There are also times when you probably should not. Here are a few examples when you probably should keep your plan where it is. 

Age 55 rule

If you are 55 years old (or 50 for qualified public safety employees) and under 59 ½ years old, separated from your employer, and are thinking about rolling over your 401K to an IRA, you may want to reconsider. There is a special rule for this age group that waives the additional 10% tax penalty that normally applies if you take money out of the plan. No such waiver applies to IRA withdrawals. While other exceptions to early withdrawals may apply to 401K and other employer plans along with IRA’s, the Age 55 rule only applies to the employer plan. If you plan to take money out to meet living expenses or retire early, rolling over the 401K to an IRA may cost you. On the other hand, if you have no plans on taking any money out, are prior to age 59 ½, and are continuing to work at another company, then a rollover may be appropriate.

Outstanding Loan

If you have a loan on your 401K plan and have separated employment, you generally have to pay off the loan in full within a limited time frame. Prior to 2018, you generally had only 60 days to pay off the loan or the outstanding balance would be deemed distributed. Under the Tax Cuts and Jobs Act of 2017, you now have until the due date of your tax filing deadline (including extensions) to pay off the loan. This gives substantially more time to avoid potential taxes and penalties. If you cannot pay off the loan, the unpaid balance will become taxable income and may be subject to additional tax penalties if you are under 59 ½. On occasion some employer plans will allow for payments to continue if you keep the plan in place even after you separate. This is not a common type of plan, but you should check to see if it is an option prior to rolling over your balance. Another option may be rolling your plan over, including an unpaid balance of a loan to another employer plan if they accept rollovers with unpaid loan balances. If you do rollover a 401K to an IRA with an unpaid loan, it will be considered taxable income and may be subject to an additional 10% tax penalty. Penalties may be waived under very limited circumstances, but the unpaid balance is considered income.

Creditor Protection

401Ks and other employer sponsored plans covered under ERISA (Employee Retirement Income Security Act) have the strongest protection against creditors based on Federal Law and past court cases. IRAs have good protection in most states under the Bankruptcy Abuse Prevention Act of 2005, however several states will not give the same protection as allowed under ERISA. States like New Hampshire, New Mexico, and California do not have the same IRA protection as other states. However, ERISA type plans such as 401K’s have protection equal across state lines and do not have the same limitations as IRAs do. For example, IRA protections are generally limited to 1 million dollars whereas 401K plans do not have this limitation. If you are in a situation where you have a pending lawsuit against you or may be considering filing for bankruptcy, do not roll your 401K balance out of the plan to an IRA because you may not receive the same level of protection against creditors. It should be noted that 401K and other ERISA plans may be subject to divorce settlements, IRS debts, and other limited circumstances.

When considering to rollover an employer sponsored plan to an IRA, other important factors should be considered. Some of these include plan costs, available investment options, professional guidance, and potential penalty free withdrawals available in IRA’s which are not available in 401K plans. It is important to weigh the pros and cons to make a fully informed decision. Seek advice from your tax consultant and or your investment advisor as each situation is unique and specific to your situation. 

Christian Bishop CFP®, EA

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