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What to do with your old 401(k). Is an IRA rollover the way to go?

Before you roll over your 401(k) to an IRA, be sure to have a firm grasp of the facts.

Should you roll over your 401(k) to an IRA?

That question may not be first and foremost during the hectic period when you leave one job and start another. But deciding what to do with your 401(k), and evaluating the IRA (individual retirement account) option, is a matter to which you will want to give some serious thought, since there is no single strategy that works for everyone.

When you leave your job, you will have several choices:
  1. You can cash in your 401(k). Consider this only if you are facing dire financial problems, since you will owe taxes on the entire amount. If you are under 59½, you will be charged a 10% penalty in addition to the taxes.
  2. You can leave the money in your old 401(k). If you have more than $5,000 in your 401(k), you can usually leave the money where it is. You will not be able to make new contributions, but the contributions you have already made, plus any matching contributions from your former employer, can remain as you have them.
  3. You can roll over the money to the 401(k) at your new company. You may have to wait until the next enrollment period or until you have been on the job a full year. And it could require extra paperwork. But don’t let these factors stop you if this is the right move for you.
  4. You can roll over the 401(k) to an IRA. Many people choose this option because it offers the opportunity to pursue a wider array of investment options, allows for greater control than being limited to your current plan's rules, and it can be a way to consolidate some of your assets. Annuities have been a popular destination for rollovers since they often provide valuable guarantees not found in 401(k) plans.

When considering rolling over the proceeds of an employer-sponsored retirement plan to an IRA, keep in mind that you have the option of leaving the funds in your existing plan, if allowed, or rolling them into a new employer’s plan, if one is available and rollovers are permitted. Each choice offers advantages and disadvantages, depending on the desired investment option and services, fees and expenses, withdrawal options, required minimum distributions, tax treatments, and your unique financial needs and retirement objectives.

Several factors to consider:

Fees: “The investment costs you pay directly cut into your returns,” says U.S. News & World Report. “If you can find similar funds outside your 401(k) plan that charge much lower fees, you will be better off switching accounts.”1 Bear in mind, though, that fees within 401(k)s are sometimes lower than those in IRAs. “A 401(k) often can access institutional pricing that everyday investors cannot,” says CNBC.2

Funding choice: “If you’re unhappy with the fund choices in your 401(k) plan, a job change is the perfect time to seek better investments with lower fees,“ says U.S. News & World Report.3 The choice of mutual funds and exchange traded funds will be far wider in an IRA than in a 401(k). This can be a big plus—but only if you take advantage of the wider choice. If you are happy with the mutual funds in your 401(k) or are the type of investor who is paralyzed by too much choice, you may be better off leaving your money where it is. Most of the funds available in your 401(k) will be available in an IRA, but a few funds that are available through 401(k)s are closed to new individual investors. Bottom line: Do your research. Map out the funds you would invest in if you rolled over your 401(k) to an IRA. If the lineup you map out is superior to what you have in your 401(k), a rollover may be in order.

Other considerations.

Protection from creditors: “If you are in debt, money held within a 401(k) could be better protected from creditors than an IRA balance,” says U.S. News & World Report.3 In addition, the money in a 401(k) is protected from most lawsuits by federal law. So if you have debt issues or are facing a legal ruling that could go against you, research your state laws carefully before you transfer your money from a 401(k) to an IRA.

Company stock: If you hold company stock within your 401(k) and it has appreciated significantly, consult your tax advisor before you roll over your 401(k) to an IRA. In some cases, you may be better off transferring the stock to a taxable brokerage account. That way, you will pay lower capital gains taxes when you sell the stock.

Loans: “If your 401(k) allows you to borrow from it, letting it stay in place can provide you with a backup when your cash starts running low,” says Bankrate. “Unlike a cash-out, the distribution for a loan is not taxed, as long as you repay the money.”4

Plan restrictions: Check your 401(k) setup. “While your money remains in your former employer’s 401(k) plan, you won’t be able to make additional contributions to the account, and you may not be able to take a loan from the plan,” says the Financial Industry Regulatory Authority (FINRA). FINRA is dedicated to investor protection and market integrity through regulation of the securities industry. “In addition, some employers might charge higher fees if you’re not an active employee.”

Your age: “Workers who take IRA distributions before age 59½ generally need to pay a 10% early withdrawal penalty,” says U.S. News & World Report. “However, people who leave their job during the calendar year they turn 55 or later can take penalty-free 401(k), but not IRA, withdrawals.”3

Tracking savings: “Consolidating money into an IRA may help investors keep better track of retirement savings,” says Kiplinger’s Retirement Report.5

If you decide that a rollover is in order, there is another choice. Should you roll over your 401(k) to an IRA or roll it over to the 401(k) of your new employer?

According to FINRA, “You should evaluate your new employer’s plan before deciding to roll your assets over. Make sure the new plan has plenty of investment choices and includes the investment options you prefer. Also check to make sure that accompanying fees aren’t too high.”6

Remember, you usually don’t need to make a decision right away. If you have $5,000 or more in your 401(k), you can leave it as is and take your time deciding on your next move. “Your employer has the option of cashing out your account if the balance is less than $1,000 (minus 20% withholding),” says FINRA, “though it must provide for the automatic rolling over of your assets out of the plan and into an IRA if your plan balance is more than $1,000.”6

Do whatever you can to avoid having your former employer issue you a check. You can still roll the money over after you receive the check. But the employer is required by law to withhold 20% for taxes. In order to roll over the entire amount, you will have to make up the difference. You will eventually get the money back, but not until after you file your tax return.

If you do a rollover, make it a direct rollover. Contact the company with which you would like to set up an IRA. It will do the paperwork for you and arrange the rollover.

If you would like to purchase a future income annuity, contact your New York Life agent. He or she will be happy to go over annuity options, help you decide which will work best for you, and arrange for a rollover. If you don’t have an agent, complete the “Contact an Agent” form and a New York Life agent will get in touch with you.

Even if you decide that an annuity7 is not right for you at the moment, it is an option you will want to consider when you reach retirement age. Having some guaranteed income8 (in addition to Social Security) will set the stage for a more secure retirement.

Neither New York Life Insurance Company nor its agents provide tax or legal advice. Consult your own tax and legal advisors regarding your particular situation.

1Emily Brandon, “What to Do With a 401(k) When You Change Jobs,” U.S. News & World Report, May 27, 2014. http://money.usnews.com/money/retirement/articles/2014/05/27/what-to-do-with-a-401-k-when-you-change-jobs
2Scott Hanson, “Rollover Rethink: 4 Good Reasons Not to Roll 401(k) Funds into an IRA,” CNBC, Oct. 22, 2014. http://www.cnbc.com/id/102086564
3Emily Brandon, “Smart Strategies for 401(k) Rollovers to IRAs,” U.S. News & World Report, June 4, 2012. http://money.usnews.com/money/retirement/articles/2012/06/04/smart-strategies-for-401k-rollovers-to-iras
4Sonya Stinson, “Cash Out, Roll Over or Leave 401(k) Behind,” Bankrate.com. http://www.bankrate.com/finance/retirement/cash-out-roll-over-or-leave-401-k-behind-1.aspx
5Rachel L. Sheedy, “Check Options Before Rolling Over a 401(k),” Kiplinger’s Retirement Report, July 2013. http://www.kiplinger.com/article/retirement/T047-C000-S004-check-options-before-rolling-over-a-401k.html
6“401(k) Rollovers,” FINRA http://www.finra.org/investors/401k-rollovers
7 An annuity payment is composed of a return of your premium (the money you put into it), interest, and an insurance component related to the issuer’s experience with claims. The amount of income you receive is based on your age, gender, premium amount, and your chosen payout option. Future income annuities are issued by New York Life Insurance and Annuity Corporation (NYLIAC), a wholly owned subsidiary of New York Life Insurance Company.
8 The guarantees of an annuity are based the claims-paying ability of the issuer.