5 myths about 401(K) rollovers: Should 401Ks (or 403bs, 457s, or TSPs) always be rolled over? Often, soon-to-be retirees are led to believe their impending retirement forces a deadline or urgency to “do something” about their retirement plan account.
Several understandable myths surround the mystery of what actually happens to your money when leaving your employer. Below are five of them.
Myth 1: When you separate from your employer, you must take your retirement plan account (401K/403B/457/TSP) with you.
Actually very few employer plans require employees to leave the plan upon retirement. You have a choice to leave the account right where it is.
This includes if you are widowed and your spouse was the employee. More than likely, you can stay with the retirement plan if you want to.
The rules for your employer can be verified by checking with your human resources department, or obtaining a copy of your plan’s complete document, usually available at your account’s website.
Myth 2: When you separate from your employer, it’s always best to take your retirement plan account with you.
Some people might not have the greatest level of fondness for their employer and want to sever ties with anything having to do with the company. While understandable, it’s important to separate facts from feelings about your money.
Due to tighter ERISA and Department of Labor regulations, it’s very unwise for employers to have their employees’ retirement plan limited to only high-fee, high-risk, or self-serving fund options. Chances are that what’s available there is worth taking a more in-depth look.
On the question of where you are best served with your retirement funds, here is where you will get a wide range of answers. You can ask friends, family, the internet, co-workers, and even ChatGPT and go in circles.
Whether rolling over your retirement plan account is in your best interest depends on a few different factors. Keep reading to myths 3, 4, and 5 to find out more.
Myth 3: Retirement plan accounts have no impact on the ability to do a Roth conversion.
False. This particularly applies to people who have IRAs outside of their employer retirement plan. If you are considering converting part of an IRA you already own outside of a retirement plan to a Roth, the amount you can convert is subject to an arcane concept called the “pro-rata rule.”
In general, under this rule, the amount you can convert is subject to a ratio that includes all IRAs, but does not include monies in employer retirement plans.
Therefore, if you roll over your retirement plan before doing a Roth conversion, you will likely limit the amount of outside IRAs you can convert. For many people retiring in their 60s and delaying Social Security, Roth conversion opportunities abound. It might very well make sense to wait to roll over at least until age 70 so that you can leave the Roth conversion option more open.
Conversely, if all of your retirement money is in the employer retirement plan and you are considering Roth conversions, then a total or partial rollover might make sense in order to then accomplish a “Back-Door Roth.”
If Roth conversions are something you are considering, it’s imperative to talk to a tax professional first before doing any rollovers, and before doing any Roth conversions.
Myth 4: Qualified Charitable Distributions (QCDs) can be made directly from a retirement plan account.
False. Qualified charitable distributions are distributions made directly from an IRA to a charity by anyone over age 70 1/2. They can only be made from IRAs, not employer retirement plans.
The reason to make a QCD is to reduce the taxability of IRA distributions. QCDs work very well for people over 70 1/2 who already have the intention and ability to give to charity, but are not able to itemize their charitable deductions.
If this is you, then you may indeed want to roll over your employer retirement plan account to an IRA so that you can accomplish QCDs from the rollover IRA. But if you’re a few years away from age 70 1/2, there’s no hurry.
Myth 5: Any investment options that you have in your retirement plan, you can also get in a rollover IRA or annuity.
False again. Some employer retirement plans offer institutional shares (often seen as “I” “R” “Y” or “Q” shares) of mutual funds, which have lower fees inside them. The minimum investment for many institutional shares is $1,000,000. Thus, the only way to access them for most retirement plan participants is to be in the plan, where your purchasing power is aggregated with other employees and retirees. Once you roll out of the plan, you may not have institutional shares available. Instead you might be limited to higher fee options common with the retail shares of funds.
Another type of fund only offered in employer retirement plans are stable value funds. Although not FDIC-insured, they are principal-guaranteed by an insurance company and generally pay a more competitive rate of interest. In some market environments a stable value fund makes a good substitute option for a short-term bond fund because it has the guaranteed principal and generally pays more than a money market fund (though not always). Nevertheless, by leaving the plan behind, this important option might be left behind, as well.
In short, rolling over your 401K is rarely a time-sensitive decision. Most people have enough going on already at a time of life transition. Take your time to talk to professionals who have no conflict of interest in advising you which way to go. For a decision this big, there’s no need to rush.
If you can relate to anything in this post and would like to talk more, we would love to listen. Schedule a call with Holly here: Contact.