The pros and cons of rolling your retirement-plan money into an IRA

When you leave a job where you have money invested in a defined contribution plan such as a 401k, or 403b you have the option of rolling that money into a personal IRA ac­count. Should you do so?

At Mentor, we frequently address this issue with new clients. Often such investments from old jobs have sat neglected in the account for years. The owner either was unaware of the options or simply didn’t have any better idea of what to do.

The simple answer is that, yes, a rollover often makes sense. But you should be aware of the pros and cons before making a decision.

Rollover advantages

  • Most retirement account investment options are fairly limited. Some­times they consist of variable annuities, which carry high fees and reduce your return, or company stock, which may be illiquid. By contrast, an IRA can be opened at a brokerage firm, giving you an almost unlimited array of investment options. Even a large mutual fund family such as Fidelity or Vanguard generally offers many more low-cost choices.
  • Rules governing the old account are controlled by your former employer and you must go through them for information or to make changes.

Rollover disadvantages

  • IRA owners must begin taking distributions in the year they turn 70½. Retirement plans usually don’t have this requirement.
  • Unless you hire an investment manager such as Mentor, there is now a greater onus on you to choose and monitor your in­vestments.
  • Retirement plans are protected from creditor claims, while IRAs may not be, depending on your state.

IRS rollover rules

Any money taken out of a retirement account is a distribu­tion and will be a tax-free roll-over if it meets the IRS require­ments. The best way to do this is called a trustee-to-trustee transfer because the money never passes through your hands.

Alternatively, you can take out the money and then put it into an IRA within 60 days. But the com­pany must withhold 20% in taxes. To accomplish a fully tax-free rollover you would then have to make up this 20% out of your own pocket. And, if you miss the dead­line, the entire amount is taxable.

Taxable distributions are taxed at your ordinary income rates and addi­tionally subject to a 10% premature withdrawal penalty if you are less than 59 ½ years old.