Before rolling over 401k or other qualified plan account balances to an IRA, give careful attention to these important considerations:
IRA Rollover Advantages
- IRAs potentially have lower administrative and fund costs than qualified plans do (although this depends heavily on your IRA provider, your investment adviser, and your investment strategy).
- IRAs allow you to consolidate multiple accounts and investment firms for fewer operational contacts and ease of administration.
- IRAs usually offer more choices in investment funds or strategies.
- Roth 401(k) balances are subject to required minimum distributions (RMDs), Roth IRAs are not.
- IRA funds may be used to pay for pre-age 59 1/2 penalty-free college expenses, qualified plan funds cannot (such withdrawals are subject to hardship withdrawal restrictions and penalty).
- IRA funds may be withdrawn any time and for any reason (although sometimes with penalty); Qualified plan hardship withdrawal restrictions are more onerous.
- Qualified charitable distributions (QCD's) may be made from IRAs, not from qualified plans.
- Beneficiary designation options are typically more flexible with IRAs and the ability to "stretch" beneficiary distributions are more robust with IRAs than with qualified plans.
IRA Rollover Disadvantages
- Tax-free "backdoor Roth" conversions become pro-rated if other traditional IRA balances exist.
- Qualified plans MAY allow pre-age 59 1/2 penalty-free withdrawals, IRAs do not (this only applies to in-service rollovers since this feature is lost after separation from service).
- Qualified plans may have a loan provision, IRAs don't (this only applies to in-service rollovers since this feature is lost after separation from service).
- Stable value funds and "GIC" type investment options only exist in (some) qualified plans, not in IRAs.
- Net unrealized appreciation (NUA) tax treatment on appreciated employer stock is lost if the stock is rolled out of a Qualified Plan.
- Qualified plan Roth balances, if rolled over to a new Roth IRA restart the 5 year withdrawal clock (not applicable if rolled into a previously-established Roth IRA in the client's name).
- IRAs offer less creditor protection than ERISA affords to qualified plans. IRA creditor protection is determined by state statute (strong in Texas).
- Investment transactions may be more difficult for self-directed investors in an IRA versus a qualfied plan.
- Qualified plans have no required minimum distribution requirement for employees if still working past age 70 1/2; IRA owners must commence RMDs at age 70 1/2 whether working or not.
- After-tax contributions within a traditional (non-Roth) qualified plan may be distributed out or converted to Roth (tax-free). Once after-tax contributions are rolled over to a traditional IRA they then become subject to the pro-rata tax rule which is less favorable.
- If you hold an annuity within a qualified plan, rolling those funds out to an IRA may cause you to lose a death benefit, income rider, or other annuity-specific benefit(s).
- Ten Year Forward Averaging: This provision of the tax code allows those eligible to calculate the tax owed on a qualified plan distribution as if the money were received over ten years rather than as a lump sum. This is only available to taxpayers born before 01/02/1936 (and only allowed on distributions from qualified plans, not IRAs).