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To Roll or Not to Roll — 401(k) to IRA

11/02/2011

This morning it is snowing like crazy here in Colorado, so instead of racing to work, I had a second cup of coffee and watched one of
the morning news talk shows.  The money topic was IRAs and the speaker—a newly minted author/expert– advocated rolling
over your 401(k) to an IRA because you would have a lot more flexibility and control over your money.  Period.  End of discussion.

Whoa! I thought.  Just a moment.  There are a few very good reasons NOT to rollover your 401(k) to an IRA – at least it should not be a simple knee jerk reaction.  You need to give it a little thought.  You will have to check our web site soon because I will do a Top Ten Things to Consider Regarding Rolling your 401(k) to an IRA.
But for blogging purposes – here are a few reasons that popped into my mind immediately after hearing the simplistic black/white, one size fits all approach presented by the expert:

  1. ASSET PROTECTION – funds in ERISA regulated plans, such as 401(k)s, may not be invaded to resolve bankruptcy claims or claims made by private creditors, period.  Well, except for the IRS, that is – more on this in a moment.  However, IRAs are not
    ERISA regulated plans.  The moment you rollover your money from a 401(k) plan to an IRA, you are exchanging federal law for
    state law (oh boy).  Every state has its own flavor of IRA asset protection or lack thereof.  I found this handy dandy guide—I cannot vouch for it, so be sure and check with your CPA or attorney to verify state law if you think you need asset protection BEFORE you roll your 401(k) to an IRA.  And be sure to notice the “statutory provision” column on this chart (scroll down thru the article to find the chart once you are on the site)  http://www.irafinancialgroup.com/selfdirectedassetprotection.php
  2.   WITHDRAWAL RULES AND PENALTIES—your age may impact the decision to roll or not to roll.  If you are age 55 or older and leaving the company, you can generally withdraw funds from a 401(k) WITHOUT penalty.  You have to wait until age 59 ½ with your IRA.  And the IRS does mean 59 ½.  It cannot be the year you turn 59 or 59 ½.  It is your official 59 ½ birthday that matters.  One of my clients got stung with this rule in 2010 (disclaimer: he did not check with us first) – withdrawing a large sum from his IRA in the year he turned 59 ½, thinking that would cover it.  Nope.  The 10% penalty was a killer.  Also to consider:  you must start withdrawing  IRA savings when you are 70 ½  (there is that crazy ½ year thing again), however, IF you are still working at 70 ½ (hey, most of us are or will be, given current economy), you can continue to participate in your company’s 401(k) plan and you are not required to withdraw.  Why is this important?  The money you withdraw is taxable and it increases your adjusted gross income, which in turn causes more of your Social Security to be taxable and lowers your ability to claim certain deductions or receive certain credits.  YES – our tax system is WAY too complicated!  But I don’t know about the 9=9=9 thing – another blog for another day.
  3. ORDINARY INCOME VERSUS CAPITAL GAINS ON COMPANY STOCK – this is really complicated stuff, but important while we still have cap gain rates of 15% and tax rates that go up to 35% for individuals.  You can actually choose to withdraw a lump sum of your 401(k) that is held in your company’s stock, pay the tax (and perhaps the penalty) on the BASIS of the stock – the amount you paid for it.  Then you can hold it and sell it after a year and a day (be careful) and receive capital gain treatment.  This is important and powerful IF the stock has appreciated in value. It is called Net Unrealized Appreciation.  If you roll over the stock into your IRA —— you will pay ordinary income tax on the whole enchilada.  You can also choose to take lump sums of only parts of the stock.  If
    you have your own company’s APPRECIATED stock in your 401(k) – GET HELP before you “simply” just roll it over into an IRA.
  4. ACCESSIBILITY – some company plans allow you to borrow from your 401(k) at very low interest rates – it is YOUR
    money after all.  As long as you pay it back within the plan’s rules or before you leave the company, you will not pay a dime of tax on the use of the money. Don’t even try this with an IRA. No Can Do.  Well…there is always an exception,  isn’t there?  You could take money from your IRA for 60 days and then pay it back…but that is really risky.  Really risky.

OK – those were just the four that popped into my mind, but since starting to jot this blog, I thought about fees, about estate issues,
about rolling to your new employer’s 401(k), about starting a business and rolling into your own 401(k) plan, about using your 401(k) money to start a business without current taxation…. Etc. Stay tuned at our web site: www.zaffore.com.

And I promised a word about our buddies at the IRS.  In my experience, I have never had the IRS levy money from a client’s IRA or 401(k).  I
think we always find some other path before that happens.  Does anyone out there have a story to tell?  I have had collections’ officers suggest strongly that taxpayers use IRA money or take a loan from a 401(k) to settle a balance due.  They have also suggested borrowing money from family and friends – true story.  And of course, if a taxpayer has a chunk of change in a retirement account over which he/she has control, the IRS may be less likely to do an offer in compromise or put the taxpayer into “currently not collectible” status.  Here is a ray of sunshine on this snowy day – if the IRS DOES levy your IRA, the withdrawal is fully taxable to you  BUT there is no penalty :).

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