Q: I am changing jobs and I am thinking about rolling my 401k into an IRA. Some people say I should just roll it into my new company’s 401k plan. What do you think?
A: This isn’t an easy decision and no single answer is right for everyone. Personally, I tend to favor IRAs for their flexibility and simplicity. However, 401k plans have some compelling benefits.
One of the most important benefits of employer-sponsored retirement plans, such as 401k plans, is that they are governed by a federal law known as ERISA. ERISA’s main intent is to make sure that plan participants are treated fairly. ERISA does the following:
1. Requires plans to provide participants with information about the plan including plan features, investment performance and fees.
2. Sets minimum standards for when an employee is eligible to participate in the plan as well as minimum benefit vesting and accrual schedules.
3. Defines who is a fiduciary for the plan and requires accountability of all fiduciaries.
4. Gives participants recourse against plan sponsors or fiduciaries who do not live up to their fiduciary duty.
My favorite benefit of 401k plans is a special clause in ERISA known as the anti-alienation provision. This provision makes it nearly impossible for creditors to lay claim on assets held in 401k plans. In fact, unless there is fraud, chances are your 401k assets are safe against all legal perils except divorce and the IRS.
IRA’s are not covered by ERISA, so IRA holders do not enjoy all of the protections that ERISA affords. IRAs provide some protection against creditors, but the amount of protection varies by state.
In California, IRA assets are protected from creditors only to the extent necessary to provide for the support of the debtor’s spouse and dependents, after considering all other resources available. This law was modified in 2007 by California’s second district court of appeals. The Court ruled that if IRA assets came from a 401k rollover, the creditor protections of the 401k apply to the IRA. This ruling obviously bolstered the position of IRA holders, though an IRA holder may have to spend some money on lawyers to claim that protection in court.
Another benefit of 401k plans over IRAs is the ability to borrow money from the plan. Although I do not usually recommend 401k plan loans, they can be a real benefit in situations where you need some liquidity to help you through a short-term money crunch.
Money crunches can result from any number of real life situations, including medical emergencies, new home purchases or college tuition payments. Whatever the reason, the 401k loan allows you to access some portion of your retirement savings without making a permanent withdrawal. You can pay the loan back whenever you want. In the meantime, you pay yourself interest. You cannot borrow money from an IRA.
Given those benefits, you may wonder why you might want to do an IRA rollover. The primary reason is flexibility. In a 401k plan you have a limited menu of investment choices. In an IRA, your investment menu is much broader and can even include investment real estate.
There are several things to consider as you think about rolling your 401k money into an IRA. I encourage you to consult with a professional financial advisor—preferably one who is a fiduciary. A trusted financial advisor can help you weigh the various pros and cons and make the right decision for you.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to email@example.com