401k - To Roll or Not to Roll

[hoost]

All,

I'm hoping some of you can lend me some of your thoughtfulness on this.  My wife is about to change jobs, and I'm trying to decide what to do with her 401k.  I see 3 options.

1.  Keep it in the existing 401k plan.
2. Roll to new employer's 401k plan.
3. Roll to IRA.

I'm still waiting to get the full plan documents for the new 401k, but it is a very large company with good match, etc., so I'm thinking it should be pretty good on fees, if not necessarily investment options.

The existing 401k is quite good, with good funds in the plan, low fees, and a brokerage window.  I'm not sure how the fees will change once she leaves the company, though.  I am under the impression that there are some plans for which the employer does not continue paying the administrative fees on behalf of previous employees.

With the rollover, I would get access to whatever funds I want, but I lose the ability to do backdoor Roth contributions, so I'm kind of thinking I'd rather not do this.

Anything else I should be thinking about?

Thanks in advance.

hoost

[Tyler]

I understand rolling the funds into a traditional IRA may change the percentage that is nontaxable in the later backdoor Roth contribution, but depending on your tax bracket, deductions + exemptions, and 401k alternatives it may still be worth it. 

I've always been nervous about leaving money in an old company 401k.  I don't know, however, if that fear is rational. 

[Tortoise]

In addition to the things already mentioned, I guess a couple of other factors to consider are convenience/simplicity and institutional diversity.

Leaving your wife's funds in her existing 401(k):

• Pros: Easy since you don't have to do anything; potentially gives you more institutional diversity
• Cons: More complicated bookkeeping to track an additional 401(k)

Rolling over your wife's funds into another 401(k) or an IRA:

• Pros: Simpler bookkeeping due to consolidating assets
• Cons: Slight one-time hassle to do the rollover; potentially reduces institutional diversity

When I changed jobs last year, even though my old 401(k) had very low fees and a brokerage window, I rolled it over into my traditional and Roth IRAs at Vanguard. (I had both traditional and Roth 401(k) balances.) All other things being equal, I just happen to prefer simplicity of bookkeeping over institutional diversity.

[WildAboutHarry]

I have always consolidated 401(k)s into our rollover IRAs whenever possible.  Like Tortoise says, it simplifies management of assets and allows for maximum flexibility of investment choices.

401(k)s and other employer-sponsored plans do have somewhat better protection from creditors, however, although rollover IRAs offer some protection as well.

[Ad Orientem]

No really strong convictions on this one... but I'd probably go with the IRA. I just feel better with more control over things. On the other hand there is an old adage with much wisdom behind it to the effect 'If it aint broke, don't fix it."

[hoost]

Thanks everyone.

I guess my first choice would have been to roll to the IRA, but I'd really rather not lose the backdoor Roth.  Is this irrational?  I guess it's only $5500 a year, but I'm quite young (28) and we are already maxing out all tax-deferred space.  Thoughts?

I think my next choice would be to roll the 401k to the new company; I'm working on getting the plan information to figure out the fees and investment options. As mentioned, this would definitely simplify things in terms of account tracking, but depending on the investments available, might end up making the portfolio more complicated.  Downside there I guess is that if the 401k plan goes downhill while she's still employed there, I would have even more money trapped in it.

I understand rolling the funds into a traditional IRA may change the percentage that is nontaxable in the later backdoor Roth contribution, but depending on your tax bracket, deductions + exemptions, and 401k alternatives it may still be worth it. 

Can you elaborate on this?  I expect that the 401k alternatives will be good, if that helps.

[Tyler]

I understand rolling the funds into a traditional IRA may change the percentage that is nontaxable in the later backdoor Roth contribution, but depending on your tax bracket, deductions + exemptions, and 401k alternatives it may still be worth it. 

Can you elaborate on this?  I expect that the 401k alternatives will be good, if that helps.

AFAIK, you don't lose the option to contribute to a Roth by having another IRA.  It simply affects the percentage that is taxable in the rollover. But even if it is fully taxable, if you're in the 15% tax bracket it may not be too bad. If you have low income, the entire amount may fall under the standard deduction + personal exemptions for a family, and you'd pay no tax.

[hoost]

I understand rolling the funds into a traditional IRA may change the percentage that is nontaxable in the later backdoor Roth contribution, but depending on your tax bracket, deductions + exemptions, and 401k alternatives it may still be worth it. 

Can you elaborate on this?  I expect that the 401k alternatives will be good, if that helps.

AFAIK, you don't lose the option to contribute to a Roth by having another IRA.  It simply affects the percentage that is taxable in the rollover. But even if it is fully taxable, if you're in the 15% tax bracket it may not be too bad. If you have low income, the entire amount may fall under the standard deduction + personal exemptions for a family, and you'd pay no tax.

Thanks.  I believe you are correct that by doing a rollover from 401k to IRA, you don't lose the ability to contribute to a Roth IRA.  I think the rollover IRA is in the same category as a traditional IRA, in that withdrawals will be taxed, etc.  The problem is when doing the backdoor Roth IRA.  In order to do this, you contribute post tax dollars to a traditional IRA, then roll the traditional IRA over to a Roth.  Since the money in the traditional IRA is post tax dollars, you do not pay any tax on the rollover.

From what I understand, if you have other pre-tax money in the traditional IRA, when you do a rollover, either to fund a backdoor or otherwise, there is some sort of calculation that considers your pre-tax and post-tax basis in the traditional IRA, and that ratio determines what percentage of the rollover is taxable funds.  I guess I need to dig into the calculation a bit more, but given then ratios here, I imagine it pretty well shuts down the backdoor Roth.

Does this make sense?

[EdwardjK]

Do you like the investment options available in your wife's current 401(k) plan?  Are the expense ratios reasonable?  If you say "yes" top both, then keep the money where it is.

Otherwise, consider transferring the money to the new 401(k) plan, assuming you like their investment options better.

Keep in mind that a 401(k) plan has asset protections not available in an IRA.  For example, if you are sued or declare bankruptcy, the 401(k) accounts are protected.

[WildAboutHarry]

[quote=EdwardjK]Keep in mind that a 401(k) plan has asset protections not available in an IRA.  For example, if you are sued or declare bankruptcy, the 401(k) accounts are protected.[/quote]

IRAs are protected from bankruptcy, at least to a limited extent.

Try this for some light reading:

[quote=TIAA-CREF]Bankruptcy Protection for Retirement Plans and IRAs

IRAs are protected from bankruptcy, thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA). As a result of this legislation, IRA investors facing bankruptcy can shield their IRA assets from creditors. While retirement plans that meet the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) — such as employer-sponsored plans like 401(k)s and 403(b)s — have long been excluded from an individual's bankruptcy estate, BAPCA extended these bankruptcy protections to IRAs and certain other investment products.

BAPCA gives IRA investors a degree of protection against creditors that didn't exist before, including additional protections to investors who frequently change jobs and may want to consolidate their multiple retirement plans into IRAs.

Here's a quick overview of what the BAPCA protections mean for IRA owners facing bankruptcy:

BAPCA only applies to bankruptcies. These protections do not shield an investor's IRA assets from other types of judgments, such as civil lawsuits. Qualified retirement plans, however, because of ERISA, are protected from both bankruptcies and other types of judgments.
Contributory and Roth IRA assets are capped at an inflation-adjusted amount of $1 million. BAPCA offers protection for all contributory and Roth IRA assets up to a $1 million limit. This $1 million cap should provide ample protection for most IRA investors, because it's unlikely that many investors have accumulated over $1 million in their IRAs. (Note that IRAs were only introduced in 1974 and, until 2002, the maximum annual contribution was just $2,000.)
Rollover IRAs are exempt from bankruptcy beyond the $1 million limit. According to BAPCA, qualified retirement plan assets that are rolled over to an IRA are completely exempt from bankruptcy proceedings, even if the amounts exceed the $1 million limit that's in place for contributory or Roth IRA assets. This aspect of BAPCA can make rolling over qualified retirement plan assets to an IRA a good strategy.
BAPCA also covers SEP and SIMPLE IRAs. Assets within Simplified Employee Plan (SEP) and Savings Incentive Match Plan for Employees (SIMPLE) IRAs are excluded from bankruptcy proceedings — and they're shielded for unlimited amounts. Additionally, BAPCA provides bankruptcy protection for Keogh plans and independent (or "solo") 401(k) plans, which are typically set up by someone operating a sole proprietorship. Because ERISA protections do not extend to either Keogh or independent 401(k) plans, the bankruptcy protections offered by BAPCA provide safeguards for investors that didn’t exist previously.
BAPCA covers certain education savings vehicles. These include Coverdell Education Savings Accounts and state-sponsored Section 529 college savings programs. Specifically, BAPCA protects any contributions made to these products for a child, grandchild, stepchild or step-grandchild more than two years before the filing of the bankruptcy petition. However, money contributed to these products for a child, grandchild, stepchild or step-grandchild made more than 365 days but less than 720 days before the bankruptcy filing are protected only up to $5,000 per beneficiary.
State laws come into play. Some states already have laws that shield residents' IRAs from creditors. However, other states don't have any protections in place, or safeguard IRAs from bankruptcy proceedings only up to a limit of $100,000. In these cases, BAPCA increases this protection up to the $1 million limit.[/quote]

[hoost]

AFAIK, you don't lose the option to contribute to a Roth by having another IRA.  It simply affects the percentage that is taxable in the rollover. But even if it is fully taxable, if you're in the 15% tax bracket it may not be too bad. If you have low income, the entire amount may fall under the standard deduction + personal exemptions for a family, and you'd pay no tax.

Thanks.  I believe you are correct that by doing a rollover from 401k to IRA, you don't lose the ability to contribute to a Roth IRA.  I think the rollover IRA is in the same category as a traditional IRA, in that withdrawals will be taxed, etc.  The problem is when doing the backdoor Roth IRA.  In order to do this, you contribute post tax dollars to a traditional IRA, then roll the traditional IRA over to a Roth.  Since the money in the traditional IRA is post tax dollars, you do not pay any tax on the rollover.

From what I understand, if you have other pre-tax money in the traditional IRA, when you do a rollover, either to fund a backdoor or otherwise, there is some sort of calculation that considers your pre-tax and post-tax basis in the traditional IRA, and that ratio determines what percentage of the rollover is taxable funds.  I guess I need to dig into the calculation a bit more, but given then ratios here, I imagine it pretty well shuts down the backdoor Roth.

Does this make sense?

But it doesn't shut down the back door Roth, it just means that you would need to pay tax on a percentage of the conversion.

Tyler's point is that it still might be worth it to you to roll the old 401k into an IRA, rather than keeping it in the old 401k or rolling it into the new 401k, depending on circumstances. 

For example, let's say you have $95,000 in the 401k, which you rolled over into an IRA, and then wanted to make a $5000 contribution to this IRA, which you then immediately roll over into a Roth.  You would end up owing tax on 95% of the $5000 (because $95,000 of the $100,000 IRA was pre-tax money).  So you'd owe tax on $4750.

If you were in the 15% tax bracket now, you'd owe $712.50.  In contrast, let's say that both the old and new 401ks only have funds with fees that are 2% or higher.  Let's also say that the fees in the IRA are 0.5% or lower.  Leaving your money in either of those places would mean you'd be paying at least $1425 more in fees for the 401k compared to the IRA.  Not to mention the fact that when you withdraw from the Roth once you are retired, you won't owe any tax.

I realize that this is an extreme example.  But I hope it helps illuminate the choice.

Thanks, this is what I thought.  At the end of the day, if you're in a situation where you need to do a backdoor Roth, your tax bracket will be much higher than 15%, but point taken.  I guess you could still contribute the $5500 post tax to the traditional IRA and if you ever had a down year you could use that as an opportunity to roll some assets over at a lower tax rate.

[hoost]

Keep in mind that a 401(k) plan has asset protections not available in an IRA.  For example, if you are sued or declare bankruptcy, the 401(k) accounts are protected.

IRAs are protected from bankruptcy, at least to a limited extent.

Try this for some light reading:

...

So it seems that rollover IRA's would not be protected from a civil suit, unless the suit was so bad that you had to file bankruptcy.