Bridget Sullivan Mermel CFP(R) CPA
401k to IRA Pros and Cons | When to do it. When to Hold Off
Rolling your 401K to an IRA used to be automatic advice, but it might not be a great idea. We talk about when to do it, and when to hold off.
The first major pros and cons to consider is how this move might impact your ability to do a back door Roth. If you max out your 401K and want to save more, back door Roths can be an appealing option, IF you don't have any IRAs.
Also, if you want to retire between age 55 and age 59 and a half, keeping the money in your 401K will give you easier access to the funds.
We'll talk about what to consider with your age and your family situation.
Plus we'll talk about how to evaluate the quality of your 401K. The quality of your 401K can be either or pro and con!
By the end of this video, you should know what to look for and how to decide if you're thinking about rolling over your money.
Here's Bridget's firm website: https://www.sullivanmermel.com
John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home
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John: Conventional Wall Street wisdom is when you leave a job, you should take your 401K and roll it to an IRA, but there are some questions about that; there are some complications and reasons why you should leave it in your 401K plan. And that's what we're going to talk about on today's episode of Friends Talk Financial Planning. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. Before we move on to our reasons or things to look for, let's make sure we remind people to subscribe. It helps us with the YouTube algorithm. Now let's just get into it. John, what is the biggest thing to think about if you're facing the decision about rolling your 401K over into an IRA?
John: I moved jobs. I got this old 401K. In some cases, I got a couple of 401Ks. Should I move it over? It sounds like a really good idea. And in a lot of cases, it is a good idea to roll it into your IRA. A rollover does not have any tax consequences. I can control all the investments. It sounds really good. However, what people don't realize, there are two big things that I think should play into this decision. And one really big one is that for people who are making a lot of money and can't do a regular Roth IRA contribution, they can do this thing called the back door Roth (and that's a whole other episode that we have on that).
But if you take your 401K and you turn it into an IRA, it basically eliminates that advantage of being able to do this backdoor Roth. It's a whole complicated thing. What people need to think about is if you want to do backdoor Roth IRA, you really can't roll that money into an IRA and have this other backdoor thing work. So that's one of the factors that nobody talks about, or I don't see anybody talking about anyway, is that rolling to an IRA basically squelches that backdoor Roth idea.
Bridget: Yeah, I would say it drastically complicates it. It doesn't eliminate it totally, but it drastically complicates it. And the other thing is that if you're going to another job, it typically makes sense to just roll it into the other job.
John: Yeah. That's a great point is you don't have to leave it in the old 401K. You can take the old 401K and turn it into the new 401K. This a really good example of why this stuff to me does not fit into saying, “Here are these things. Everybody should do this.” It's complicated. There are different choices. You've got a different choice than the next person. I've got different things, so there are other options.
That's a great point to bring up is that you can take an old 401K and turn it into your new 401K if you change jobs. And it's not that it's wrong to roll it into your IRA, but think about this backdoor Roth idea and think about whether you can do it. And to your point, I say it “eliminates it;” it doesn’t. You can still do it. It's just that it generally doesn't make sense to do it—in my mind anyway.
Bridget: And it just complicates it.
Bridget: You've got another point, too, if you're right around the age of 55. Let's talk about that.
John: That's right. So one is the backdoor Roth. The other reason why you might want to leave the 401K where it is, is a little-known rule. A lot of people know, “If I put money into my retirement plans, when I'm 59 and a half, I can take it out, without paying any penalties.” Well, there's one part of the IRS code that says, “If I'm working and I'm 55 or older when I retire from this job, I can access my 401K money without that 10% penalty.”
So the 59 and a half rule usually applies to IRAs and retirement plans in general, but if I'm working at the university and I take my 403B and I'm 56 and I leave the money in my 403B or 401K, I can have access to that without any 10% penalty. And so, that gives you a lot of flexibility for people that are retiring at 55, 56, 57—anytime between 55 and 60. Again, does it mean that you should leave it in the 401Ks? No. You have a lot of other things to consider, but nobody ever talks about the idea that maybe you should leave that money where it is because you have access to it without worrying about that 10% IRS penalty.
Bridget: And similar to the drastically complicated with backdoor Roths, there are other ways to get at your IRA money without a penalty before you are 59 and a half. But they take. So I call it “gymnastics.” You got to tie yourself up in a pretzel to do it. And it's not like you can't do it or we don't do it with people.
Bridget: You can do it, but it's not as easy as saying, “Hey, give me a $10,000 withdrawal.
John: Right. And I love that pretzel idea. You got to do these things. And then in this particular one, you've got to stay in the pretzel. You've got to keep that same format until you're over 59 and a half. So you can do it, but it's complicated. And we like to give examples of these things. We've got a client of ours who recently retired, and she was just about 56 years old, and said, “Oh, Jeez, 401K, it's not bad, but it's not awesome. Should we move this over into an IRA?”
So we had a long discussion about does it make sense to do this or not? And one of the things is whether there’s some other money available. We've done some planning from a tax standpoint to be in a really low tax bracket, but having money in this 401K plan, working at the company, retiring after 55. If she leaves that money there, anytime in the next five years, if things change, like maybe inflation goes really high or there's no pandemic that happens—these sorts of things—just ideas😊
You have access to that money without paying any penalty and without going through the pretzel gymnastics of the other side of things. Having flexibility could be really important, and it isn't an automatic roll it into an IRA sort of conversation. So we’ve just gone through this recently and having a lot of flexibility, being able to adapt what goes on, what peace of mind comes from that.
Bridget: Exactly. So you're saying that it gives you more flexibility to keep it in your 401K?
John: That's right. And so I think this is a great time to segue perhaps into asking, “Okay, does that mean never roll your 401K over to an IRA?” No, it means you need to think about these things. What types of things do you talk about with people as you make this decision about doing this?
Bridget: Well, the first thing, and we've kind of hinted at that, is how old are you? And if you're married, what is your spouse's situation, too? Sometimes people don't realize that they're going to want to do backdoor Roths in the future, or they might stop working, but their spouse is still working, or they might pick up some work—and you don't have to work that much to be able to do a backdoor Roth.
For most people, you don't have to put in the max, but you can. So asking, “How old are you?” is one of the biggest questions. So usually for younger people, we tell them, okay, if you want to keep things simple, just roll it into your next 401K. If again, the next question is what's the quality of your 401K? Now that's something we look at. I don't know if other people are as hip with that. They’re asking what exactly that means?
John: Right. You take a look at expenses and options of investments that you have and things. For a lot of our clients that come in, they think, “I got these great company benefits.” And in a lot of cases, the company benefits are great. And in a lot of cases, you look at them and you go, “Holy man, that is just not an awesome retirement plan.” It's really expensive, and it's sort of buried in there. Or, there're not very many options or there's a whole bunch of options and they're all basically the same thing. Again, how does a regular person know that? So the quality of the plans makes a big difference.
Bridget: The way that I discern that is by asking, “Are there index funds in their investment options and what is the cost of the investment funds?” And I look for low cost, which is, let's say, under 0.2%, not 1%.
Bridget: So that would be an actual low cost.
John: All these things are interrelated. It doesn't make any difference on getting money out unless you're already 55.
John: But if you're or younger, then you might ask, “How does my old 401K plan compare to my new 401K plan? And how do those things work? Do I ever plan to work again?” If you're a single person that might take on a different flavor than if you're married—and if your spouse is working or not working. Maybe you can already do Roth contributions because of where your income is, so the backdoor thing doesn't apply.
There’s all these things that tie into this decision. It's just not this cookie cutter. My problem with much of the financial world is that it says, “Listen, after you have your 401K, roll it into an IRA here.” The big firms that sponsor 401K plans think, “Great! We can do that. Keep your money with us. We can put it in an IRA.” Well, golly, maybe it makes sense for the client to leave it in the 401K plan.
So all the messaging says that you should take this and put it into an IRA. And I'll tell you, compared to taking the money out and paying taxes and penalties, which unfortunately a lot of people do, yes, rolling it into an IRA is a much better alternative. But it's just not this one-size-fits-all thing. So it's not one-size-fits-all in my mind to roll your 401K plan into an IRA, and it's also not one-size-fits-all to leave it in the 401K. You've got to look at your situation and really pay attention to these two things we're talking about here today.
Bridget: Yeah. And so I think I want to say it's explicitly wherever you have your 401K, they're making some money off of it. So if it's in your IRA, they're making some money. If you have it in your old 401K, they're charging you some money. And so, asking, “How much are they charging me to move it over here? Is this part of my overall financial planning? What's the situation here?” Being aware of that is something we think about and that other people don't talk about. And so, we feel like sometimes people are getting advice that has a conflict of interest in it when it's just mindlessly moving into an IRA.
John: Right. And so I think that's probably a great place to wrap things up here. I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. We're both proud members of the Alliance of Comprehensive Planners (ACP). If you like the way that we talk about finances, you'll probably like the way that other ACP planners talk about it, too. You can check it out at acplanners.org.
John: That's right. And don't forget to hit that subscribe button. Until next time, Bridget.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.