(Money Magazine) -- Question: When I retire, should leave my money in my company's 401(k) or roll it into an IRA? --Mark, Plymouth, Minnesota
Answer: I hate to start with that overused phrase "it depends." But the fact is that the right answer really does hinge on your particular circumstances, not to mention the characteristics of your 401(k) plan.
For example, two factors that can definitely influence your decision to stay or go are your age and how soon you'll dip into your 401(k) stash for living expenses or other needs.
If you're at least 55 when you leave your company, you qualify for an exception from penalties that apply to withdrawals prior to age 59 ½. That means you can pull money from your 401(k) account and pay only income tax on the taxable portion of the withdrawal. By contrast, if you roll your money into an IRA and begin pulling it out, you'll not only owe income tax on withdrawals prior to age 59 ½, but a 10% penalty as well.
So if you're at least 55 but under 59 ½ and you think you'll need access to your 401(k) money over the next few years, you'll probably want to keep at least a portion of your dough in your company plan, at least until you hit 59 ½.
(Yes, you can avoid the penalty on early IRA withdrawals by taking "72(t)" withdrawals withdrawals -- that is, substantially equal periodic payments based on your life expectancy -- but that can get kind of messy.)
Generally, though, I think most people who are retiring or already retired are probably better off rolling their 401(k) balance into an IRA.
For one thing, if you stay in your 401(k), you're limited to the investment choices within your plan. That may not be so bad if your 401(k) has a broad menu of decent investments that are reasonably priced. (To get an idea of how your plan's investment options stack up on price, check out the 401(k) fee reports available free from 401(k) ratings firm BrightScope.) But by rolling your savings into an IRA at a mutual fund or brokerage firm, you give yourself access to thousands of different mutual funds, ETFs and other investments.
Not that you need thousands of choices. I think most people are better off keeping things simple and making a diversified portfolio with just a handful of funds. But the point is that by expanding the roster of funds available to you, you may have a better shot at finding low-cost funds. With an IRA rollover you'll likely be able to pick and choose from more index funds and more target-date retirement funds than your 401(k) presently offers.
Another thing you want to consider is how much flexibility you would have for drawing money if you remain in your 401(k). Can you set up a systematic withdraw plan or do you have to put in a separate request each time you need cash? Can you designate which funds draws will come from, or does the plan administrator pro rate the withdrawal amount across your holdings? Does your 401(k) allow for lifetime annuity payments? If so, are the payments competitive with what you can get outside the plan?.
With an IRA rollover, you'll probably find you'll have more maneuvering room. You can pull money out as needed. You can ask the investment firm handing the IRA to pay you a specific amount or a specific percentage of your account value each month. You can use some of your assets to purchase an immediate annuity that will turn that portion of your savings into guaranteed lifetime income. Or you can do all three.
Until recently, there may have been another reason to go with the IRA rollover even if you were partial to sticking with your 401(k) plan: only a spouse beneficiary had the option of rolling an inherited 401(k) into an inherited IRA and then stretching out payments over his or her life expectancy. A nonspouse beneficiary was required to take the 401(k) money (and pay tax on it) within five years of the 401(k) owner's death.
So if you were thinking of leaving your 401(k) to someone other than your spouse, you would give that beneficiary a lot more flexibility on withdrawals and taxes by rolling your money to an IRA.
But the Pension Protection Act of 2006 eliminated that discrepancy. Actually, that's not quite right. After the act became law, initial interpretations of the legislation said that it gave 401(k) plans the option of allowing nonspouse beneficiaries to roll over the inherited 401(k)'s assets into an inherited IRA. In short, 401(k) plans didn't have to offer that choice.
But a subsequent notice from the IRS makes it clear (well, clear to people who read IRS notices) that starting this year 401(k) plans must make the 401(k)-to-inherited IRA option available to nonspouse beneficiaries. Be aware, though, that the beneficiary has to follow some very specific rules to do this correctly, including setting up a special inherited IRA to accept the rollover and doing the transfer via a trustee-to-trustee transfer.
Bottom line: before you make a decision, take some time to think about such issues as when you'll need access to your money, how much flexibility you'll have getting to it in your 401(k) vs. an IRA rollover and, of course, how much you'll pay in expenses staying in your plan vs. doing a rollover. I suspect that most people will opt for the IRA, especially if they're 59 ½ or older. But the only way to know which is the better choice is to think it through.
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