Yellowstone Financial, Inc.

Perils of Moving Your Retirement Plan

When you wrap up your position with a company, you typically get the option to roll your account over an IRA, Roth IRA, or retirement plan with your new employer.  In most cases, it makes sense for you to do this.  We’ve seen clients come into the practice with balances in several different retirement plans, which a former mentor would call “the weed garden.”

It’s a challenge to optimize your investments with accounts spread over many different plans.  Trying to pick the best mutual funds from four different menus that change from year to year can be a challenge for professional investors, let alone individuals.  Also maintaining your desired stock and bond mutual fund mix in line with your goals can be a challenge if you have funds in several different plans.

However, there are some cases when rolling the funds over to a personal Roth or traditional IRA is a bad idea.  Here are some key instances when you should put the brakes on transferring out funds from your retirement plan.

Early Distributions.  If you’re an early retiree, you could lose some key options If you move funds over from a retirement plan to a traditional IRA.  Most 401(k) and 403(b) plans allow for you to take funds out without penalty if you leave the employer after you turn 55 years old.  If you’re fortunate enough to have a 457(b) plan at work, such as state employees, then you can withdraw funds even earlier as long as you’ve left employment.  If you move these plans over to an IRA, you may have to wait until age 59 ½ to withdraw the funds without a 10 percent penalty.

Company Stock.  If you work for a company that grants stock or allows you to purchase it inside your retirement plan, then you have powerful tax advantages that you lose once you roll it over to an IRA.  This only applies to company stock inside a retirement plan.  This does not apply to employee stock purchase plans, stock grants, or stock options.

Imagine you work for X Corporation and they allow company stock to be held in your retirement plan.  You’ve worked there for a number of years and have built up $100,000 in X stock in your plan.  Over the years it has appreciated in value, and you’ve only paid a grand total of $30,000 for the stock.  If you perform the distribution correctly under the Net Unrealized Appreciation rules, then you only pay ordinary income tax on $30,000 even if the plan distributes $100,000 of X stock directly to you.  Once you sell the stock, you pay much lower capital gains tax rates on the gain.  This could save you thousands in taxes.

Better Investment Options.  Workplace retirement plans are on a slow march of improvement, in some cases offering better investment options than can be found in your own IRA or Roth IRA.  One prominent example is the federal government’s Thrift Savings Plan, which has a bond investment option called the G Fund that is not available in any other investment.  It allows you to earn the interest rate of a longer-term Treasury bond, with absolutely no risk that it will go down in value.  While it may make sense to move some of your TSP funds elsewhere, leaving a balance to invest could be the wise choice.

Another reason to leave funds in a retirement plan is that they arguably provide higher levels of creditor protection if you’re in a high risk field, although this protection does extend to IRAs and Roth IRAs to a degree.  Plus retirement plans can offer an old-school defined benefit pension, which gives you a payment each month for life that is almost always a better deal then taking the lump sum.  Finally, keeping your pre-tax accounts in workplace retirement plans can also give you access to a backdoor Roth IRA, a method of upper income workers to contribute to a Roth IRA by convoluted means.

There are many advantages to rolling over retirement plan balances to an IRA or Roth IRA of your own.  You have more investment choices.  You can more easily use the services of an investment professional (and pay them in pre-tax dollars).  You can track your investments and rebalance with great ease.  Just make sure you don’t have a compelling reason listed above to keep your retirement plan with your old employer.