Question: I plan to retire soon. I have a 401(k) retirement account with my employer, and want to use this account to supplement my Social Security and investment income during retirement. Should I roll the account over to an IRA? What concerns should I have?
Answer: We’ve all seen the rollover ads from brokerage, insurance, and mutual fund firms. Recent ads in the media ranging from the New York Times to Sunset Magazine by Fidelity Investments tell us “Reconnect your old 401(k) to your new plans,” or “More Possibilities – Move your old 401(k) to a Fidelity Rollover IRA.”
In a recent Google search for “401k rollover” the first three links told me: (1) I could roll over my old 401(k) plan to a certain insurance company's IRA; (2) I could get help consolidating my retirement savings with rollover help from a certain mutual fund company; and (3) a certain online brokerage firm would pay me up to $600 to roll over my old 401(k) to an IRA.
With over $5 trillion sitting in 401(k) and other U.S. defined contribution retirement accounts, it’s no wonder financial firms are increasing their focus on your 401(k) in their hunt to gather more assets. However, before you respond to one of these ads, you need to know what they are not telling you.
This week I will tell you why a rollover might be a really good idea and also what you should know if you have company stock in your 401(k) account. Next week I’ll list the things to watch out for. (Click here to view Part 2: "4 Cautions for 401(k) Rollovers")
Many 401(k) plans have hidden costs that put a drag on performance and offer a limited number of investment options. If you roll over your 401(k) to an IRA at a brokerage firm, you will more than likely have access to a much larger and better selection of investments, including stocks, bonds, ETFs, and mutual funds from many different fund companies. This might benefit you if you are a knowledgeable investor or if you work with an investment advisor. Equally important, you will have much better control over costs.
If you have company stock inside your 401(k) account, you need to be careful and work closely with your advisor. The IRS offers favorable capital gains tax treatment on the gain in value of the company stock that you have accumulated inside your retirement plan. But you will lose this favorable tax treatment if you include the company stock in the rollover to an IRA.
By moving the stock to a separate non-IRA, you can take advantage of “Net Unrealized Appreciation” (NUA), which is the value of the stock on the date of distribution (the day you take it from the 401(k)) minus its value on the date it was purchased in your 401(k). You will pay long-term capital gains tax (currently capped at a 20% federal tax rate) on the NUA when you sell the stock (compared to the higher ordinary income tax rates you would pay if you sold it in your IRA account and then withdrew the proceeds). You will also pay capital gains tax on any appreciation in the price of the stock between the distribution date and the day you sell it.
Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to email@example.com.