retirement

Learn the pros and cons of IRA rollovers

Don TaylorDear Retirement Adviser,
What are the advantages and disadvantages of converting a 401(k) to an individual retirement account?

Thanks,
-- Bill Benefits

Dear Bill,
Performing an individual retirement account rollover from a former employer's 401(k) plan can give you wider investment choices and potentially reduced annual fees and other expenses. You also have the option to convert to a Roth IRA, which allows you to pay income taxes upfront and to take qualified distributions tax-free once you retire. This option typically works best if you pay the tax bill from funds other than those held in the 401(k). The 401(k)-to-Roth-IRA conversion would be used if you expect to be in a lower tax bracket now than when you start tapping retirement funds.

As for me, I've done it both ways. I've kept money with previous employers to gain access to mutual funds that I wouldn't be able to invest in on my own in an individual retirement account. I've also moved money from a prior employer to a traditional IRA.

Most 401(k) plans don't give you the ability to buy individual stocks. If you move the 401(k) account funds to an IRA brokerage account, you'd be able to invest in stocks, bonds, mutual funds and exchange-traded funds, or ETFs. Do-it-yourself investors are often attracted to these choices.

Paying advisory fees isn't a bad option for most people uncomfortable with making their own investment decisions. Advisory fees are an added expense, but many people believe they are a reasonable price to pay for professional management.

401(k) and company stock ownership

If any of the money in your 401(k) was used to purchase your previous employer's stock, you should work with your tax professional before making any rollover decisions.

If there is substantial net unrealized appreciation on the stock, then you benefit from the shares of stock being moved into a taxable investment account. This is at the same time your other 401(k) holdings are being rolled over into a traditional or Roth IRA. Done correctly, the appreciation in the company stock qualifies for tax treatment as capital gains. That should be at lower tax rate than your ordinary income rate.

Because of this added complication, it would not be a do-it-yourself transaction.

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