Moving your money: Pros and cons

Key Points

  • Your prime earning years are an ideal time to look into rollover options
  • Certain types of conversions enable greater tax flexibility
  • Rollovers could improve your investment and distribution flexibility

With the dawn of a new year, it’s not uncommon to consider moving or “rolling over” some of your assets for greater investment control or improved tax diversification — especially with April 17 approaching and new tax legislation top of mind for many. We talked to Amy Diesen, Vice President of Retail Retirement Plans at Ameriprise, about the pros and cons of different types of rollovers.

Should you contribute after-tax funds to a 401(k) and then roll over into a Roth IRA?

It’s a consideration for many who aren’t eligible for a Roth IRA due to 2018 income limits (starting at $120,000 for an individual and $189,000 for a married couple filing jointly). Here’s what you need to know:

  • Some 401(k) plans allow for additional after-tax contributions above the limits that apply to 2018 pre-tax or Roth deferrals ($18,500 per year, or $24,500 for those 50 or older).
  • Additional after-tax contributions can typically be converted to Roth IRA assets once a year — even if you are still working and your income is above the contribution limits.
  • Keep in mind that after-tax contributions to a 401(k) plan do count against overall annual retirement account contribution limits in 2018 ($55,000 per year, or $61,000 for those 50 or older). Your plan administrator may also set a contribution limit.

There are reasons to consider rolling over retirement funds into a Roth IRA and reasons not to, Diesen says. Some 401(k) plans may allow for a conversion to a Roth 401(k) inside the plan, but you may gain more investment and tax flexibility through converting after-tax funds to a Roth IRA. Ask your Ameriprise advisor to review the “After-tax 401(k) to Roth IRA conversions” and “Leave it or Roll it” brochures with you for a detailed discussion of the strategy and pros and cons of rolling over to an IRA.

Here are the basics for 401(k) after-tax conversions to Roth IRAs: 

Should you consolidate investments in one place?

Leaving 401(k) plan assets in your existing company-owned plan may give you access to institutional funds that charge less in fees than funds outside an employer plan, but there are many other factors to consider as well. Investment options and control, distribution flexibility, and creditor protection are just a few of the things you should keep in mind. Depending on your situation, it may make sense to consider consolidating your retirement assets in one place.

“It’s not uncommon for people to change jobs several times in their career, resulting in what we call ‘401(k) orphans.’ By consolidating investments in one place, assets can be managed and diversified by risk tolerance, tax liability and years to retirement,” Diesen says.

One option is to roll your 401(k) into a traditional IRA, which may provide you with more investment choices and control over future distributions.

“Your employer determines the rules for participants, and they may limit distributions to a single lump sum or a certain number per year,” Diesen says. “With an IRA, you decide the timing of distributions.” This flexibility can be a big plus when it comes to your retirement income strategy.

Should you roll over your employer plan while still working?

If your employer plan allows, at age 59 1/2 you can take advantage of an option known as an in-service distribution (ISD). An ISD allows you to access money in your retirement plan while you’re still working. One option available to you with an ISD is to roll over the assets to an IRA.

The primary advantage of taking an ISD to roll over assets from a 401(k) to an IRA is greater control over the distribution and investment options of your retirement funds prior to your retirement date. “It may be important for some retirees to have more flexibility as they get closer to retirement,” Diesen says. “With an IRA, you’re an owner rather than a participant, which means you can select from a variety of investment options.” 

So what about drawbacks? While an employer-sponsored qualified plan such as a 401(k) allows participants who retire at 55 or later to take distributions without the 10% IRS premature distribution penalty, IRAs generally do not allow penalty-free distributions until age 59 ½. IRAs may also have less protection from creditors in a non-bankruptcy situation than 401(k)s, depending on the state in which you reside. Some other possible disadvantages to taking an ISD to roll over assets from a 401(k) to an IRA may include:

  • Fees and expenses
  • Tax treatment of employer securities
  • Restrictions on future contributions

For example, it may be a good idea to leave highly appreciated employer stock in a 401(k). “There are special tax breaks available for employer stock that is distributed in kind from an employer plan that don’t exist in an IRA. Those who have employer stock need to carefully consider if it makes sense to roll over those assets to an IRA,” Diesen says. This is a decision that is irrevocable, so it is vital to get it right the first time.   

Talk to us

Before rolling over funds, Diesen encourages working with a financial advisor to help strategically consider your options within the context of your bigger financial picture. “You only get one shot at this,” she says. “An advisor can help ensure you stay on track with financial goals.”

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