Dear Dan,
A bunch of us are getting laid off and most of my co-workers are hot to rollover their 401(k)s to an IRA. Our HR person says we do not have to do that and we should carefully consider our options. Why wouldn’t someone roll their 401(k) to an IRA?
– Sam
Dear Sam,
Sorry to hear about the job loss.
Your HR person is correct that most workers do not have to do anything with their 401(k) after leaving. If they have a vested balance over $5,000 ($7,000 starting in 2024), they can leave those funds where they are.
We find that most people that are laid off, want to get their money out of the 401(k) due to some degree of anger. However, there are several factors that can make leaving the money in the 401(k) smart. I’ll just touch on a few that come up frequently.
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One comes into play for anyone older than 55 (age 50 for qualified public safety employees) but younger than 59 ½. Workers that separate from service in the year they turn 55 or later, even if before their 55th birthday, may tap the 401(k) without paying the customary 10% penalty for being under age 59 ½. This penalty waiver is not available from IRAs so rolling into an IRA may cause the person to incur a penalty if they need funds.
Read: If saving $23,000 in your 401(k) next year isn’t enough, you can double that (or more) with the right strategy — and it’s legal
Another factor that can point to leaving the funds in the 401(k) is the quality of the investments in the plan. Some plans have an excellent array of low-cost investment options. We see this more often with larger plans.
Also, creditor protection is an important consideration for some. In general, 401(k)s are federally protected, whereas IRAs are protected by state laws that vary from state-to-state.
You don’t necessarily have to get laid off or quit to roll money out of a 401(k) to an IRA. Many plans allow “in-service distributions” once workers reach 59 ½. There are too many differences between 401(k)s and IRAs to cover here but I’ll touch on a few common reasons to roll the funds to an IRA.
Read: New rules mean required withdrawals from retirement accounts have become even more complex
Probably the most common motivator to roll to an IRA is the desire for better investment options. While I mentioned how some plans have an excellent array of low-cost investment options, many 401(k)s have the opposite. This is especially true for smaller plans which can be loaded with high fees or limited choices.
With a 401(k), the employer decides what investment options will be available. In an IRA, you can choose from a much larger universe of options and that level of control appeals to many.
Many 401(k)s do not allow for customized beneficiary designations. If your wishes for how those funds are to be distributed don’t match what is allowed by the plan, rolling to an IRA can be preferable.
Lastly, most people find IRAs provide much more flexible options and processes for administering distributions. The paperwork is often simpler and there are usually few if any restrictions on how frequently funds can be paid out or what the tax withholding can be.
If you have a question for Dan, please email him with ‘MarketWatch Q&A’ on the subject line.
Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
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