Don't Rollover that 401(k) to an IRA

From Bob Jennings at TaxSpeaker. Check out TaxSpeaker at taxspeaker.com

If you are like me, I get sick of hearing every “investment advisor” say you need to rollover your 401k to an IRA, as if failure to do so is a major mistake. Of course, rolling a 401k to an IRA has a number of advantages, but these commission-oriented “advisors” never talk about the reasons to leave your 401k alone. I have both a 401k and an IRA, recognizing the advantages of both, and will continue to have both accounts until death because the 401k has tremendous advantages.

Presented below is a list of strong reasons to leave money in your 401k.

1.    A 401k (or any qualified plan), at your death, may be rolled over to their own IRA by your heirs, even when they are not your spouse. An IRA must be fully withdrawn within 10 years after your death by any heir other than your spouse.

Let’s say I have $250k in an IRA and $250k in a 401k. The beneficiary of my IRA is my 9 year old grandson,  Kiernan. If I die, he must fully withdraw it by the end of the 10th year after my death, and no, for you smart guys, he is not an “eligible designated beneficiary” because he is my grandson, not my son. If I leave it to my wife however, she can roll it to her own IRA.

What if I leave Kiernan my 401k of $250k? He can setup a new IRA in the name of the deceased to receive the rollover. But, he will still have to withdraw the entire amount within 10 years after my death, but by rolling it to an IRA he will lose the benefits below. Many advisors suggest immediately rolling over the inherited 401k to an IRA, citing this rule, but I say hold on, let’s look at the bigger picture.

2.    A 401k offers unlimited protection from creditors, but an IRA’s protection is limited to an inflation adjusted $1,000,000 in bankruptcy ($1.7 million in 2025). For a large 401k, particularly if owned by an individual in a high liability field or with creditor issues, a rollover would be disastrous, exposing the excess in an IRA to creditors, whereas leaving it in the 401k protects it.

3.    A 401k (or qualified plan) allows an individual who leaves their 401k employer for any reason at age 55 or over to withdraw without the 10% early withdrawal penalty at age 55 instead of age 59 and ½ that applies to IRAs. If that same individual rolls the 401k to an IRA they forfeit the age 55 special rule.

4.    Similarly, the age 50 special rule allowing public safety employees to withdraw without penalty at 50 or older is lost if rolled to an IRA and replaced with the age 59 and ½ rule.

5.    If still working for the 401k sponsor at age 73, even if part-time, there is no requirement to begin required minimum distributions (except for owners). An IRA does not offer this option, even if it is funded from a 401k rollover.

6.    The act of rolling a 401k to an IRA with an “advisor” invariably means the “advisor” will make investments in the IRA, with a resultant commission paid to the “advisor”. It may take many years to earn enough extra money to offset these fees, particularly when many 401k plans offer free advisory services/.

7.    The 401k plan fees are almost always much lower than the fees charged by independent “advisors”. Additionally, many IRAs charge annual account maintenance and operational fees.

8.    You can borrow up to $50,000 (currently) from your 401k without tax or penalty. You may not borrow from your IRA.

9.    An IRA forfeits the incredible NUA rule available to a 401k. Let’s say your 401k has company stock in it, for which you paid $25,000 over the years. Today it is worth $200,000. If you roll the stock to an IRA you will pay tax on the full value as you withdraw it. However, if you take it out of the 401k, you will pay ordinary income rates on the $25,000 cost. You will not pay tax on the net unrealized appreciation until you actually sell the stock, and even then you only pay capital gains rates. This NUA treatment is lost if the stock is rolled to an IRA.

Rolling a 401k to an IRA is often an excellent plan, but too often we see commission-oriented advisors failing to bring up the advantages of leaving the 401k alone. If the adviser does not discuss these rollover negatives, then I would seriously consider whether the advice is good!