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Robert Powell

11 reasons to leave your 401(k) behind

8/16/12 12:01 AM ET (MarketWatch)Print

BOSTON (MarketWatch)--If you lose your job or leave your employer, many wise a person will tell you to roll your 401(k) into an IRA. But experts say that might not always be prudent, and that there are plenty of reasons to leave your 401(k) with your former employer.

To be sure, you have to examine your own personal circumstances and decide what's best for you, but here's our laundry list of reasons--other than inertia--to leave your retirement account behind.

1. No 10% penalty on distributions

For starters, workers who lose their job between ages 55 and 59½ and who leave their 401(k) with their former employer can withdraw money from that account without having to pay a 10% penalty to Uncle Sam.

That's not the case with an IRA. If you roll your 401(k) into an IRA and then withdraw money from that account prior to age 59½ you will--with some exceptions--pay a 10% penalty on the distribution. After age 59½, you can of course withdraw money from an IRA without having to pay the 10% penalty. (You will pay an ordinary income tax on the distribution from either the 401(k) or the IRA.)

For the record, Barry Picker, of Picker & Auerbach CPAs, said the ability to withdraw prior to age 59½ without penalty works only if you separate from service in the year you turn age 55, or later. But that is definitely a reason to leave it," he said.

Picker, for what it's worth, noted that a taxpayer who rolled a 401(k) into an IRA and then took a distribution tried to argue against the 10% penalty in a recent court case, but lost.

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For his part, Ross Marino, the CEO of Rekon Intelligence, agrees that being able to withdraw money from a 401(k) plan without have to pay the 10% penalty is a plus. "With downsizing, job insecurity and early retirement for many, being able to access monies without a 10% early withdrawal penalty is important," he said.

One strategy that you might want to consider is what Marino calls a "partial rollover." Here's how it would work: If a worker who separates from service needs $20,000 per year between ages 55 and 59 ½, he or she may execute a partial rollover. The displaced worker would leave $80,000 or so in their 401(k), and roll the balance to an IRA. "If the 401(k) offers a competitive fixed account, this may be a low risk way to provide four years' worth of income," said Marino.

There is at least one advantage to moving your 401(k) to an IRA worth noting according to Natalie Choate, who practices law with Nutter McClennen and is the author of "Life and Death Planning for Retirement Benefits." "IRAs allow a $10,000 penalty-free distributions for a first-time home purchase, as well as penalty-free distributions for certain education expenses, neither of which applies to a 401(k)," Choate said.

And there's another exception worth noting. You can roll your 401(k) into an IRA and take distributions prior to age 59½ without paying the 10% penalty by using what's called the 72t rule, according to Katherine Roy, executive director of J.P. Morgan Asset Management Individual Retirement.

"If you were to rollover your funds to an IRA, the 72t rule allows you to also take distributions prior to 59½ without being subject to the 10% penalty, but you are signing up for a specific payment schedule--the payments must be 'substantially equal' and must continue for a minimum of five years or until you reach age 59½, whichever is longer," said Roy.

2. Company stock better left behind

According to Jeffrey Levine, an IRA technical consultant with Ed Slott & Co., keeping money inside a 401(k) could leave the door open for certain tax-saving strategies, such as the tax benefit for Net Unrealized Appreciation (NUA) or 10-year averaging.

"These are both lump-sum distribution options, which means everything must leave the plan in one tax year," said Levine. "There are also a myriad of other rules that apply, which is why before rolling over a 401(k), people should consult with a knowledgeable adviser who can let them know if they qualify for either of these--or other--special tax breaks and whether they would make sense."

FYI: You would consider using the NUA option if you have highly appreciated company stock. If that's the case, you would want to wait on rolling it over until age 59½ and the roll over the account taking advantage of the NUA while avoiding the 10% penalty, said Phillis Sax Pilvinis, the founder and president of PSP & Associates.

You might want to leave your 401(k) that contains company stock behind for other reasons, too. "Many times individuals have company stock in their 401(k) that they do not want to sell because they believe in the future of the company," said Don Chamberlin, Jr., the CEO and president of The Chamberlin Group. "And who can hardly blame them, because of the experience with their employer they probably know more about the stock than their broker."

3. Lower fees

Marino and others say leaving your 401(k) behind might be cheaper than rolling it over to an IRA. For one, 401(k) plans tend to offer low-cost investment options, typically institutional class mutual funds that are much less expensive than the retail mutual funds available to IRA investors. "Years ago, 401(k) plans offered limited investment options," said Marino. "Now, many 401(k) plans offer similar options to professionally-managed accounts with competitive fees."

Scott Dingwell, head of participant communications within BlackRock's U.S. and Canada defined contribution group, agreed. "Many corporate 401(k) plans have negotiated fees that amount to buying 'wholesale'," he said.

One exception: Small 401(k) plans are generally less able to negotiate lower fees so there might be no cost advantages if you participate in a small plan.

What's more, your old 401(k) may have funds or models customized to the plan that have performed well and cannot be replicated in an IRA, said Eric Levy, a senior vice president with Lincoln Financial Group's retirement plan services group.

Levy also noted that some 401(k) plans have a self-directed brokerage account that offer lower transaction charges than retail brokerage accounts.

In addition, it may be cheaper to keep your balance in the 401(k) plan because many plans don't charge fees for keeping your balance in the plan, said Kevin Crain, head of institutional retirement and benefit services for Bank of America Merrill Lynch. "IRAs often charge an account or maintenance fee, commissions, and the like," Crain said.

4. Access to advice

Having access to a managed account services such as those provided by Financial Engines or Morningstar Retirement Manger or GuidedChoice is another reason to leave your 401(k) behind. "The fees for managed account services inside a 401(k) cost the participant on average 0.3% to 0.6% vs. 1% to 2% for similar services outside your old 401(k)," said Levy.

In addition, Levy said participants may have access to one-on-one in-person support through a retirement consultant for guidance and education which they will typically not have with an IRA. "This is especially important for people with assets under $100,000 as they are typically on their own or in a call center service model," he said.

5. Better oversight

If you don't have an adviser looking over your IRA, it might be better to leave your 401(k) behind. With a 401(k) plan, the employer has a fiduciary responsibility to provide ongoing oversight of the plan and its costs.

"No one is going to be a fiduciary over your IRA," said Levy. "Whenever you leave a job, you should get objective information about the full range of investment options, including those offered by your current provider, and understand how your choice will affect your ability to preserve and grow your savings."

6. Guaranteed products

In some cases, you might have to leave money in your 401(k) because of the products you own. According to Levy, some 401(k) plans have the option of in-plan income guarantees, which may not be transferable.

In other cases, you might want to leave the money behind because you have access to institutionally priced annuity payout options that are better inside a 401(k) than outside the plan. "Many 401(k) plans are taking a close look at a new breed of retirement income funds that will allow participants in these plans to convert part or all of their balance into a source of guaranteed income for the duration of retirement--no matter how long one might live," Dingwell said. "Given the current risk many of us face that we might run out of money in old age, having access to these soon-to-arrive products may be a critical reason to stay put."

And in still other cases, you might have access to guaranteed funds that you trust. "Some 401(k) plans provide a guarantee fund or other investment options that workers like because of the known result," said Bill Bailey of Wealth Management Advisors. "They can set it and forget it. For many workers this is what they need."

One such company providing this option in their 401k plan, for instance, was Eastman Kodak, said Bailey. That plan, prior to Eastman Kodak seeking bankruptcy protection, provided a Fixed Income Fund known as Fund D that nearly everyone participated in because of its guaranteed yield, he said. "It became the anchor of many personal retirement plans for workers, former workers, retirees and retirees widows or widowers. Once workers were in this fund they never wanted to change," said Bailey.

7. Better creditor protection

According to Picker, leaving your money in a 401(k) gives you--possibly--better protection against creditors. "ERISA plans, a 401(k) for example, are protected under federal law but IRAs are protected under state law which can vary state to state," Picker said.

Choate agreed. "Your 401(k) is generally much safer from creditors than your IRA," she said. "The only exception is a solo practitioner small business owner where it doesn't make much difference."

Levine said it's worth checking the creditor protection your IRA has in your state. "In some states, that protection is virtually as strong as the creditor protection afforded by ERISA, while in other states, it may be much weaker," Levine said. "People should make sure to know the rules in the state where they live."

Levine also offered this reason for keeping money in a former employer's 401(k) plan. "Sometimes, when I meet with doctors, lawyers, contractors or other professionals who face a higher-than-average risk of being sued, they are particularly concerned about the creditor protection of their retirement savings," he said. "If this is a big concern for them, then it may pay to keep their money inside a 401(k) instead of rolling it over to an IRA."

8. Access to loans

If you have a family-owned business, and you're contemplating transferring ownership to your heirs, it might make sense to leave your 401(k) behind too, according to Don Clark, CFP, of Personal Financial Group. Often, it's advantageous for the primary owner or owners, who typically have the largest percent of assets in the 401(k), to leave the assets in the plan in order to help control and minimize total plan expenses, which is based on total plan assets, for the remaining participants.

In addition, a retiring business owner who leaves their 401(k) has access to an emergency fund of sorts. "I have had an occasion when a retiring business owner has left the assets in the plan so in a difficult financial situation for the business arose and credit was tight, they were able to access a 401(k) loan to cover a short-term credit crunch," Clark said. "While I don't recommend this situation often, this has helped in the recent years when it was difficult for some small businesses to access money."

9. A way to buy life insurance

One of the better reasons to leave money in a company plan is to get life insurance, said Joe Felicetti of R. Seelaus & Co. "A person who cannot get an individual life insurance policy, because of medical reasons, may be able to participate in a group insurance policy through a company plan, Felicetti said. "You cannot buy life insurance in an IRA, but money in company plans can be invested in life insurance."

What's more, Felicetti said, this may be the only way a person can come up with the money to pay the premiums.

10. Divorce and 401(k)s

And if you are getting divorced, you might have to leave the money behind in your 401(k) for legal reasons. "It is often a few years before this asset can be touched so a former worker cannot move it until the final decree or QDRO, or Qualified Domestic Relations Order, is complete," said Bailey. "This is a legal item and the courts can be prohibitive on moving retirement resources."

If a divorced spouse under age 59½ receives a 401(k) account through a QDRO, he or she may be wise to leave the account inside the 401(k), according to Terry Prather, a wealth planner with Payne Wealth Partners.

"A 401(k) received through a QDRO provides an exception to the 10% early withdrawal penalty," Prather said. "If the individual instead rolls the assets to an IRA, the 10% penalty will apply to any withdrawals prior to age 59½."

But even if you are not involved a divorce, you might want or need to leave the 401(k) behind, according to Joseph Clark CFP, RFC, and managing partner with The Financial Enhancement Group. "Qualified plans require spouses to be the primary beneficiary where IRA plans do not," he said.

11. Other reasons

There are many other reasons to leave your 401(k) with your former employer. For instance, if you leave your money with your old 401(k), you might have an easier time of transferring that money to your new employer's 401(k).

What's more, beneficiaries can move money from an inherited 401(k) to an inherited Roth IRA, which they cannot do with an inherited traditional IRA, Picker said.

Also, if you have been contributing to a non-deductible IRA each year and have no other IRAs, you can convert that IRA to a Roth. In essence, you've circumvented the income limitation on Roth contributions, Picker said. If, however, you move your 401(k) to an IRA, "the Roth conversion would have to prorate all IRAs and would make the conversion taxable," said Picker.

Another adviser gave this example: If you are doing a Roth conversion in the same tax year as a rollover to an IRA and you have after-tax contributions to either your IRA or 401(k) you need to be aware of aggregation rules. Basically, you can't only convert your after-tax contributions to lower your tax bill. All your IRA assets, including any 401(k) rollovers the same tax year, will be included in the aggregation. You will need to apply taxes on the percentage of before-tax and after-tax IRA assets.

And still yet another reason is this: If you work for an investment firm, say a private equity firm, you often get access to private deals in your 401(k) that you would lose if you moved out to an IRA, said Choate.

Robert Powell is editor of Retirement Weekly, published by MarketWatch. Learn more about Retirement Weekly here.