July 15, 2025 • 16 mins
Your 401(k) is likely your largest retirement asset—so the decisions made about it can have a lasting impact. This episode explores the pros and cons of keeping a 401(k) versus rolling it over to an IRA.
Learn when it makes sense to stay in a 401(k), especially for those retiring between ages 55 and 59½, when a special IRS rule allows penalty-free withdrawals not available in IRAs. Keeping pre-tax funds in a 401(k) may also support more efficient backdoor Roth strategies.
Six key factors influence the decision: cost, control, investment options, account consolidation, ease of use, and coordination across accounts. The discussion also dives into advanced strategies—such as in-plan Roth conversions, the tax treatment of after-tax contributions, and Net Unrealized Appreciation (NUA) for company stock.
The right choice depends on individual retirement timelines, tax strategies, and long-term financial goals. This episode helps uncover what to consider before making a final decision.
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Advisory services are offered through Root Financial Partners, LLC, an SEC-registered investment adviser. This content is intended for informational and educational purposes only and should not be considered personalized investment, tax, or legal advice. Viewing this content does not create an advisory relationship. We do not provide tax preparation or legal services. Always consult an investment, tax or legal professional regarding your specific situation.
The strategies, case studies, and examples discussed may not be suitable for everyone. They are hypothetical and for illustrative and educational purposes only. They do not reflect actual client results and are not guarantees of future performance. All investments involve risk, including the potential loss of principal.
Comments reflect the views of individual users and do not necessarily represent the views of Root Financial. They are not verified, may not be accurate, and should not be considered testimonials or endorsements
Participation in the Retirement Planning Academy or Early Retirement Academy does not create an advisory relationship with Root Financial. These programs are educational in nature and are not a substitute for personalized financial advice. Advisory services are offered only under a written agreement with Root Financial.
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Episode Transcript
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Speaker 1 (00:00):
Think you already know what to do with your 401k
when you retire.
You might want to think again,because the wrong decision with
this could potentially cost youmany thousands of dollars over
the course of your lifetime.
Now here's the thing with 401ks.
I'm a financial advisor, and meand other advisors I work with
over just the past few weekshave talked to many different
clients about what to do withtheir 401ks, and there was not
one single answer that fitappropriately for everyone.
(00:21):
There's many differentpotential things you can do, and
so what I'm going to do todayis explain the various factors
involved, various considerations, and explain which one might be
most relevant given yoursituation, so you can make the
right decision for you.
The reason this is so importantis that for most retirees,
their 401k is going to be theirlargest retirement asset, so if
you don't get this decisionright, the impact of that could
(00:42):
cost you dearly.
So let's walk through thedifferent factors that you need
to consider when deciding whatto do with your 401k.
To start, let's talk about whenyou should not roll over your
401k, because typically, youroptions are going to be do you
keep your money in your 401k ordo you roll over to an IRA.
There's some other things thatyou can do, but those are the
two main options.
Here's why you wouldn't want tomove money out of your 401k.
(01:04):
Number one, if you're retiringbut you're not yet age 59 and a
half, but you are over the ageof 55.
If you have a 401k with acompany that you are working at
in the year in which you turn 55, you actually have different
rules for when you can accessthat money penalty free.
If you have an IRA, you can'ttouch that money until age 59
and a half, with very fewexceptions.
(01:25):
But with a 401k, that rule isactually turned to 55 if you're
working at the company that youhave that 401k through when you
retire.
So, for example, you're 56years old, you want to retire,
you have all of your money inthat company's 401k.
You think that you can't touchmoney until you're 59 and a half
, but that's only if you were totake those 401k assets and roll
(01:46):
them to an IRA.
Because you are already age 55or above and because you're
currently working at thatcompany, you could retire from
that company and pull money fromthat 401k without the 10%
penalty.
You still owe taxes, but youremove the 10% early withdrawal
penalty.
So this option can provide youa lot more flexibility for those
of you who are not yet age 59and a half but want to retire in
(02:09):
your 55 or older with thecompany that the 401k is through
.
Why do I say that?
Well, if you're 55 and you haveyour 401k with this company but
you have a previous employerwho you also have an old 401k
through, you can't touch that401k until you're 59 and a half.
The 401k through you can'ttouch that 401k until you're 59
and a half.
The 401k has to be with thecompany that you are working
(02:30):
with upon the year in which youattain age 55.
So here's a potential planningstrategy If you're with that
company, you can always rollover previous 401ks into your
current company's 401k and thatway, when you do retire, much
more of it becomes available toyou.
But just keep that in mind.
The company that you have your401k through.
The age at which you can accessthose funds is 55, not age 59
(02:50):
and a half, like it is fortraditional IRAs.
So that could be one very goodreason not to roll over your
401k into an IRA.
The second good reason not toroll over your 401k is if you're
doing backdoor Rothcontributions.
So the way backdoor Rothcontributions work is
technically, you're making anIRA contribution that's
non-deductible and you'reconverting that non-deductible
contribution into your Roth IRA.
(03:11):
When you do this and I've donevideos that explain this in more
detail but when you do this,the IRS has what's called an
aggregation rule, where it'slooking at all the different
IRAs.
You have to determine how muchof that conversion is taxable.
So when you do this and I'llkeep this short because, like I
said, if other videos thatexplain this in more depth you
don't want any pre-tax IRAassets.
This includes simple IRAs andSEP IRAs.
(03:34):
Instead, if you keep thosefunds in your 401k, they're not
included in the aggregation rule.
So if you are doing a backdoorRoth contribution, this is a
very important detail, probablythe most important one that
trips people up the most.
I would explore this in moredetail.
Talk to your CPA, talk to yourfinancial advisor, before
actually doing this.
If you're not doing backdoorRoth contributions, this is not
(03:54):
as relevant.
Let's now talk about otherconsiderations that you should
be looking at when it comes todeciding do you keep your money
in a 401k or do you roll it overto a traditional IRA.
Number one is cost.
Now, thankfully, things havegotten a lot better in the last
several years.
It used to be very common tosee 401ks with a whole bunch of
hidden fees.
You wouldn't think you'repaying anything because you
don't necessarily see anythingon your statement, but when you
(04:16):
start to unpack the cost of thefunds that you're invested in or
the cost of the plan, you couldsee fees as high as two, two
and a half percent sometimes.
Thankfully, that seems to becoming down because there are
better, lower cost options,especially if you're with a
larger company.
Typically, you're going to havea lower cost plan it's not
universal, but that tends to bethe case but there can be some
hidden fees in 401k.
(04:38):
That's not to say there are notalso fees in IRA, even hidden
fees in IRA.
What it it does mean, though,is you do need to explore the
difference.
What is the all-in cost of the401k that you're in?
What is the all-in cost of theIRA that you might transfer the
funds to?
If you're going to have an IRAthat's self-directed, typically
you're going to be able to do soat a lower cost at least a
(04:58):
lower cost potential than youwould in a 401k, but understand
the cost of each and understandwhat's best for you.
The second consideration iscontrol.
Generally speaking, in an IRA,it's going to be a lot easier to
trade.
It's going to be a lot easierto make monthly transfers or
distributions on demand.
It's going to be a lot easierto implement conversions, which
is a strategy that a lot ofpeople do in retirement.
So if you're keeping your moneyin a 401k, that's perfectly
(05:21):
fine.
Maybe there's some good reasonsto do so.
But just understand, isflexibility, is control, is ease
of use important to you?
Typically, an IRA is going tobe a lot better for that, and
this is not a universalstatement, but just on average.
You're gonna have a bit morecontrol If you need to make the
one-off distributions or takemonthly distributions, if you
need to make the trade, if youneed to do the conversion, if
(05:41):
you want to do that in a timelymanner.
Iras typically have a lot moreflexibility, a lot more of an
ability for you to do thosetypes of things.
The next factor to consider isinvestment options.
Usually, with a 401k, you'regoing to have some limited set
of investment options.
These options might befantastic or they might be
pretty crummy options.
It's going to depend upon theplan, but in general, your
(06:03):
options are going to be far morelimited than they would be in
an IRA.
Now, that's not always a badthing.
Sometimes 401ks pick verystrong options.
What this could potentially dois prevent people from
unknowingly purchasing a reallybad fund or something that's
really inappropriate for them,specifically a high risk fund,
something that's veryspeculative.
401ks don't typically offerthose types of options.
So if you want a limited fundlineup because you know it's
(06:25):
going to prevent you frompicking something that might not
be the best for you, you canmake the case that 401ks are
great for that are great forthat.
But if you want unlimited fundoptions, if you really want to
build the portfolio that'sperfect for you and what you
need you're probably not goingto get that through a 401k.
With few exceptions, withlimited exceptions, you're going
to be better off in an IRA interms of having more fund
(06:47):
options to choose from to buildthe portfolio that's right for
you.
So understand who you are as aninvestor.
Do you want the more limitedoptions to prevent you, maybe,
from picking really bad options,but it might also prevent you
from picking the best optionsfor you.
Some people might want that,but for others, if you want
unlimited flexibility to say howdo you build the right
portfolio for you?
The IRA in general is probablygoing to be the better bet.
(07:09):
The fourth factor to consider isjust organization and
consolidation.
It's very common to meet peoplewho have five, six, seven old
401ks and what you start torealize is it just becomes kind
of cumbersome.
It's a bit of a hassle toactually understand what do I
have?
What's it worth?
What is it invested in Allthese various accounts?
Ideally, you should be keepingthose accounts organized.
You could do that in a 401k,meaning anytime you change jobs,
(07:32):
roll over your previouscompany's 401k into your new one
.
Now, like we've gone throughbefore, you want to understand
what are the costs where theinvestment options, what's the
flexibility, what's theexperience like.
But that's not a bad option ifall those things are good to
keep your funds organized.
Or do that in an IRA Every timeyou leave an old job, take your
401k, roll it over to an IRA,which just stands for individual
(07:54):
retirement account, meaning youhave far more control over it
and you do the same thing there.
But either way, you want tomake sure that you're staying
organized so you don't end upwith half dozen dozen different
accounts that you're not reallytracking or managing
appropriately.
The fifth factor is ease of use.
I already kind of touched uponthis, but, generally speaking,
the right IRA provider is goingto give you a whole lot easier
(08:15):
experience, better userexperience, because it's not a
group plan, because there's notall these different third-party
administrators or record keepersor other parties you might need
to go through.
An IRA is streamlined, it'sclean, it's easy, the
accessibility is there, thetools are there.
It just tends to be an easierprocess Not always the case, but
that's often the case.
So understand what's the easeof use with whatever 401k you
(08:38):
have, with whatever IRA optionalso exists out there.
Then the sixth factor toconsider is just coordination
between different accounts.
If you have a robust financialplan, chances are good you have
a strategic asset allocation andasset location across all your
different accounts, meaning youhave the high level.
Here's the investment mix Iwant to have and you go a step
beyond that to say, of thisinvestment mix, of this asset
(08:59):
allocation, where do I want tohold each of the different types
of investment classes or assetclasses?
It makes sense to hold some ofthese in my brokerage account
versus others in my traditionalIRA, versus others in my Roth
IRA.
If you have a 401k.
It's a bit more difficult tocoordinate that when you have
different platform, differentlogins to view everything,
versus if you have everything inone place, which tends to be
(09:22):
the case.
If you have an IRA or Roth IRAsor brokerage accounts, you can
hold all of those at the sameinstitution.
It's easier to see what is theoverall mix and how is
everything distributed betweenthe various types of accounts.
So those are six factors toconsider and now I want to go
into some specific planningpoints that may be incredibly
impactful for many of you.
The first is understand thedifferent tax treatment of
(09:42):
different types of 401kcontributions.
It's not uncommon to say youhave one 401k statement.
There might be a million bucksin that.
That's not all treated equally.
Some of that was your owncontribution, some of that was
an employer contribution.
Some of that was your owncontribution.
Some of that was an employercontribution, some of that was a
pre-tax contribution, some wasa Roth contribution, some was an
after-tax contribution, somewas growth on the after-tax
contribution and even thoughit's one balance, it's not all
(10:03):
going to roll over to the sameplace if and when you move that
to an IRA.
So here's how that works.
Any pre-tax contributions thatyou make, those roll over to a
traditional IRA if you want todo so in a tax-free way.
Any matching contributions thatyour employer made those also
roll over to a pre-tax IRA.
Now here's the catch Even ifyou are making Roth
contributions, any matchingcontributions that your employer
(10:25):
made those will roll over to atraditional IRA.
Those are pre-tax contributionsat the company level, which
means they're going to bepre-tax on the way out and
they're going to go into atraditional IRA, not a Roth IRA.
Now, any Roth contributionsthat you made and, by the way,
one of the beautiful thingsabout Roth 401ks is it doesn't
matter what your income is.
(10:45):
There's no income limits youcan make Roth 401k contributions
and those contribution limitsare much higher.
So anything that youcontributed to the Roth 401k and
any growth on those Roth 401kcontributions, that all rolls
over to a Roth IRA if you'regoing to move that out of your
401k balance.
Here's a tricky piece.
A lot of 401ks offer what arecalled after-tax contributions.
If you make an after-taxcontribution, you're not getting
(11:09):
a deduction on thatcontribution.
So any dollars that youcontribute to that, that dollar,
that contributed amount, rollsover to a Roth IRA when you
contribute to that, that dollar,that contributed amount, rolls
over to a Roth IRA when you movefrom that company or when you
do that rollover.
But and this is a veryimportant catch any growth on
those after-tax contributions,that's all considered pre-tax
and that would all roll over toyour pre-tax IRA.
(11:32):
Here's why that's so important.
If you have after-taxcontributions that you're making
and if your plan allows forin-plan conversions, what you
want to do is convert thoseassets to your Roth 401k.
It doesn't cost you anything intaxes, assuming you do it
immediately.
So, for example, I make a$10,000 after-tax contribution
(11:52):
to my 401k, I don't get adeduction.
That's why that $10,000 couldmove to my Roth IRA when I roll
it over.
But if I keep it in theafter-tax balance, any growth on
that is pre-tax Pre-tax,meaning when I do pull it out it
will be taxable.
But if, instead, I make that$10,000 contribution, I then
convert it to my Roth 401k,there's no taxes on that
(12:15):
conversion because I didn't geta deduction when I made the
contribution.
Therefore it's not taxable.
When I convert it, I've alreadypaid my taxes.
The difference is now anyfuture growth on that balance is
going to be tax-free becauseit's happening in my Roth.
It's not happening in theafter-tax balance.
So that single decision couldbe something that saves you
thousands and thousands and tensof thousands of dollars over
(12:35):
the course of your retirement.
Because let's assume I makethat $10,000 contribution and I
let this thing ride for a longtime and it grows to $30,000.
If I had not converted it, that$20,000 of growth is now all
taxable to me when I doultimately take it out and start
spending it.
Versus I simply done thatconversion, that $20,000 would
be completely tax-free.
(12:55):
So very important thing to notewhen it comes to distributing
funds from your 401k into yourIRA and the things that you can
do in the meantime to make surethat you're optimizing the
taxation of those contributions.
Another very important detailfor people that have 401ks and
have company stock in their 401kis you need to consider net
unrealized appreciation as apotential strategy here.
(13:16):
So net unrealized appreciationyou'll see it abbreviated as NUA
.
What that means is you areeligible for preferential tax
treatment on any of the gainsthat you've realized on the
purchase of that company stock.
For example, let's assume thatyou've put in $50,000 to your
401k specifically towards yourcompany stock and your company's
(13:37):
done tremendously well, so that$50,000 is now worth $500,000.
Well, if you were to roll thatall over to an IRA, that
$500,000, once you start pullingit out is completely taxable,
and it's taxable at ordinaryincome rates.
Ordinary income rates are thehigher rates that you're going
to pay.
What net unrealized appreciationwould allow you to do is, it
would say, take that $500,000that's in your company stock,
(13:58):
and there's some details here.
So work with your financialadvisor, work with your
accountant to make sure thatyou're doing this the right way.
But that $50,000, when you takeit out, might be subject, or
would be subject, to ordinaryincome taxes, but the gains on
that, the $450,000 of gains,that would be subject to capital
gains treatment.
Now there are some planningstrategies here, because that
(14:19):
tax hit is immediate, whereasyou're rolling over a 401k or
rolling over a balance that canbe deferred, that can be spread
out over time.
But make sure that you do theanalysis to see if that would be
a good strategy for you,because that can potentially be
worth tens of thousands ofdollars or more, depending upon
how much you have in companystock and depending upon your
tax bracket.
And then the final thing to notehere, just reiterating what we
talked about before is if youhave an IRA, there's going to be
(14:41):
a 10% early distributionpenalty anytime you take funds
before age 59 and a half.
Time you take funds before age59 and a half, there's a couple
of exceptions first time homebuyer, if there's a disability,
medical things like that but ingeneral, 10% early distribution
penalty if you take funds before59 and a half.
With the 401k, that age dropsto 55.
You have to have worked at thecompany that is holding the 401k
(15:04):
up until the year in which youturn 55.
But if you do so, that's a fourand a half year difference in
terms of how long you need towait to avoid that early
distribution penalty.
So when should you use a 401k?
When should you use an IRA?
Generally speaking, if you havea 401k with low cost, great
investment options, you mightneed access to the funds before
age 59 and a half.
You don't need a tremendousamount of flexibility in terms
(15:25):
of trading, conversions etc.
401k might be the best optionfor you.
If that's not the case, if youdon't have great investment
options, if the cost is quitehigh, if you do want more
flexibility or ease of use orcontrol and you don't need those
funds before 59 and a half.
Generally speaking, it might bebest to consider an IRA for
situations like that, so there'spros and cons to both.
(15:46):
Understanding what's mostrelevant to you is the most
important thing to determiningwhether you should use the 401k
or the IRA as you approach yourretirement.
Once again, I'm James Canole,founder of Root Financial, and
(16:07):
if you're interested in seeinghow we help our clients at Root
Financial get the most out oflife with their money, be sure
to visit us atwwwrootfinancialpartnerscom.
Think you already know what to do with your 401k
when you retire.
You might want to think again,because the wrong decision with
this could potentially cost youmany thousands of dollars over
the course of your lifetime.
Now here's the thing with 401ks.
I'm a financial advisor, and meand other advisors I work with
over just the past few weekshave talked to many different
clients about what to do withtheir 401ks, and there was not
one single answer that fitappropriately for everyone.
(00:21):
There's many differentpotential things you can do, and
so what I'm going to do todayis explain the various factors
involved, various considerations, and explain which one might be
most relevant given yoursituation, so you can make the
right decision for you.
The reason this is so importantis that for most retirees,
their 401k is going to be theirlargest retirement asset, so if
you don't get this decisionright, the impact of that could
(00:42):
cost you dearly.
So let's walk through thedifferent factors that you need
to consider when deciding whatto do with your 401k.
To start, let's talk about whenyou should not roll over your
401k, because typically, youroptions are going to be do you
keep your money in your 401k ordo you roll over to an IRA.
There's some other things thatyou can do, but those are the
two main options.
Here's why you wouldn't want tomove money out of your 401k.
(01:04):
Number one, if you're retiringbut you're not yet age 59 and a
half, but you are over the ageof 55.
If you have a 401k with acompany that you are working at
in the year in which you turn 55, you actually have different
rules for when you can accessthat money penalty free.
If you have an IRA, you can'ttouch that money until age 59
and a half, with very fewexceptions.
(01:25):
But with a 401k, that rule isactually turned to 55 if you're
working at the company that youhave that 401k through when you
retire.
So, for example, you're 56years old, you want to retire,
you have all of your money inthat company's 401k.
You think that you can't touchmoney until you're 59 and a half
, but that's only if you were totake those 401k assets and roll
(01:46):
them to an IRA.
Because you are already age 55or above and because you're
currently working at thatcompany, you could retire from
that company and pull money fromthat 401k without the 10%
penalty.
You still owe taxes, but youremove the 10% early withdrawal
penalty.
So this option can provide youa lot more flexibility for those
of you who are not yet age 59and a half but want to retire in
(02:09):
your 55 or older with thecompany that the 401k is through
.
Why do I say that?
Well, if you're 55 and you haveyour 401k with this company but
you have a previous employerwho you also have an old 401k
through, you can't touch that401k until you're 59 and a half.
The 401k through you can'ttouch that 401k until you're 59
and a half.
The 401k has to be with thecompany that you are working
(02:30):
with upon the year in which youattain age 55.
So here's a potential planningstrategy If you're with that
company, you can always rollover previous 401ks into your
current company's 401k and thatway, when you do retire, much
more of it becomes available toyou.
But just keep that in mind.
The company that you have your401k through.
The age at which you can accessthose funds is 55, not age 59
(02:50):
and a half, like it is fortraditional IRAs.
So that could be one very goodreason not to roll over your
401k into an IRA.
The second good reason not toroll over your 401k is if you're
doing backdoor Rothcontributions.
So the way backdoor Rothcontributions work is
technically, you're making anIRA contribution that's
non-deductible and you'reconverting that non-deductible
contribution into your Roth IRA.
(03:11):
When you do this and I've donevideos that explain this in more
detail but when you do this,the IRS has what's called an
aggregation rule, where it'slooking at all the different
IRAs.
You have to determine how muchof that conversion is taxable.
So when you do this and I'llkeep this short because, like I
said, if other videos thatexplain this in more depth you
don't want any pre-tax IRAassets.
This includes simple IRAs andSEP IRAs.
(03:34):
Instead, if you keep thosefunds in your 401k, they're not
included in the aggregation rule.
So if you are doing a backdoorRoth contribution, this is a
very important detail, probablythe most important one that
trips people up the most.
I would explore this in moredetail.
Talk to your CPA, talk to yourfinancial advisor, before
actually doing this.
If you're not doing backdoorRoth contributions, this is not
(03:54):
as relevant.
Let's now talk about otherconsiderations that you should
be looking at when it comes todeciding do you keep your money
in a 401k or do you roll it overto a traditional IRA.
Number one is cost.
Now, thankfully, things havegotten a lot better in the last
several years.
It used to be very common tosee 401ks with a whole bunch of
hidden fees.
You wouldn't think you'repaying anything because you
don't necessarily see anythingon your statement, but when you
(04:16):
start to unpack the cost of thefunds that you're invested in or
the cost of the plan, you couldsee fees as high as two, two
and a half percent sometimes.
Thankfully, that seems to becoming down because there are
better, lower cost options,especially if you're with a
larger company.
Typically, you're going to havea lower cost plan it's not
universal, but that tends to bethe case but there can be some
hidden fees in 401k.
(04:38):
That's not to say there are notalso fees in IRA, even hidden
fees in IRA.
What it it does mean, though,is you do need to explore the
difference.
What is the all-in cost of the401k that you're in?
What is the all-in cost of theIRA that you might transfer the
funds to?
If you're going to have an IRAthat's self-directed, typically
you're going to be able to do soat a lower cost at least a
(04:58):
lower cost potential than youwould in a 401k, but understand
the cost of each and understandwhat's best for you.
The second consideration iscontrol.
Generally speaking, in an IRA,it's going to be a lot easier to
trade.
It's going to be a lot easierto make monthly transfers or
distributions on demand.
It's going to be a lot easierto implement conversions, which
is a strategy that a lot ofpeople do in retirement.
So if you're keeping your moneyin a 401k, that's perfectly
(05:21):
fine.
Maybe there's some good reasonsto do so.
But just understand, isflexibility, is control, is ease
of use important to you?
Typically, an IRA is going tobe a lot better for that, and
this is not a universalstatement, but just on average.
You're gonna have a bit morecontrol If you need to make the
one-off distributions or takemonthly distributions, if you
need to make the trade, if youneed to do the conversion, if
(05:41):
you want to do that in a timelymanner.
Iras typically have a lot moreflexibility, a lot more of an
ability for you to do thosetypes of things.
The next factor to consider isinvestment options.
Usually, with a 401k, you'regoing to have some limited set
of investment options.
These options might befantastic or they might be
pretty crummy options.
It's going to depend upon theplan, but in general, your
(06:03):
options are going to be far morelimited than they would be in
an IRA.
Now, that's not always a badthing.
Sometimes 401ks pick verystrong options.
What this could potentially dois prevent people from
unknowingly purchasing a reallybad fund or something that's
really inappropriate for them,specifically a high risk fund,
something that's veryspeculative.
401ks don't typically offerthose types of options.
So if you want a limited fundlineup because you know it's
(06:25):
going to prevent you frompicking something that might not
be the best for you, you canmake the case that 401ks are
great for that are great forthat.
But if you want unlimited fundoptions, if you really want to
build the portfolio that'sperfect for you and what you
need you're probably not goingto get that through a 401k.
With few exceptions, withlimited exceptions, you're going
to be better off in an IRA interms of having more fund
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options to choose from to buildthe portfolio that's right for
you.
So understand who you are as aninvestor.
Do you want the more limitedoptions to prevent you, maybe,
from picking really bad options,but it might also prevent you
from picking the best optionsfor you.
Some people might want that,but for others, if you want
unlimited flexibility to say howdo you build the right
portfolio for you?
The IRA in general is probablygoing to be the better bet.
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The fourth factor to consider isjust organization and
consolidation.
It's very common to meet peoplewho have five, six, seven old
401ks and what you start torealize is it just becomes kind
of cumbersome.
It's a bit of a hassle toactually understand what do I
have?
What's it worth?
What is it invested in Allthese various accounts?
Ideally, you should be keepingthose accounts organized.
You could do that in a 401k,meaning anytime you change jobs,
(07:32):
roll over your previouscompany's 401k into your new one
.
Now, like we've gone throughbefore, you want to understand
what are the costs where theinvestment options, what's the
flexibility, what's theexperience like.
But that's not a bad option ifall those things are good to
keep your funds organized.
Or do that in an IRA Every timeyou leave an old job, take your
401k, roll it over to an IRA,which just stands for individual
(07:54):
retirement account, meaning youhave far more control over it
and you do the same thing there.
But either way, you want tomake sure that you're staying
organized so you don't end upwith half dozen dozen different
accounts that you're not reallytracking or managing
appropriately.
The fifth factor is ease of use.
I already kind of touched uponthis, but, generally speaking,
the right IRA provider is goingto give you a whole lot easier
(08:15):
experience, better userexperience, because it's not a
group plan, because there's notall these different third-party
administrators or record keepersor other parties you might need
to go through.
An IRA is streamlined, it'sclean, it's easy, the
accessibility is there, thetools are there.
It just tends to be an easierprocess Not always the case, but
that's often the case.
So understand what's the easeof use with whatever 401k you
(08:38):
have, with whatever IRA optionalso exists out there.
Then the sixth factor toconsider is just coordination
between different accounts.
If you have a robust financialplan, chances are good you have
a strategic asset allocation andasset location across all your
different accounts, meaning youhave the high level.
Here's the investment mix Iwant to have and you go a step
beyond that to say, of thisinvestment mix, of this asset
(08:59):
allocation, where do I want tohold each of the different types
of investment classes or assetclasses?
It makes sense to hold some ofthese in my brokerage account
versus others in my traditionalIRA, versus others in my Roth
IRA.
If you have a 401k.
It's a bit more difficult tocoordinate that when you have
different platform, differentlogins to view everything,
versus if you have everything inone place, which tends to be
(09:22):
the case.
If you have an IRA or Roth IRAsor brokerage accounts, you can
hold all of those at the sameinstitution.
It's easier to see what is theoverall mix and how is
everything distributed betweenthe various types of accounts.
So those are six factors toconsider and now I want to go
into some specific planningpoints that may be incredibly
impactful for many of you.
The first is understand thedifferent tax treatment of
(09:42):
different types of 401kcontributions.
It's not uncommon to say youhave one 401k statement.
There might be a million bucksin that.
That's not all treated equally.
Some of that was your owncontribution, some of that was
an employer contribution.
Some of that was your owncontribution.
Some of that was an employercontribution, some of that was a
pre-tax contribution, some wasa Roth contribution, some was an
after-tax contribution, somewas growth on the after-tax
contribution and even thoughit's one balance, it's not all
(10:03):
going to roll over to the sameplace if and when you move that
to an IRA.
So here's how that works.
Any pre-tax contributions thatyou make, those roll over to a
traditional IRA if you want todo so in a tax-free way.
Any matching contributions thatyour employer made those also
roll over to a pre-tax IRA.
Now here's the catch Even ifyou are making Roth
contributions, any matchingcontributions that your employer
(10:25):
made those will roll over to atraditional IRA.
Those are pre-tax contributionsat the company level, which
means they're going to bepre-tax on the way out and
they're going to go into atraditional IRA, not a Roth IRA.
Now, any Roth contributionsthat you made and, by the way,
one of the beautiful thingsabout Roth 401ks is it doesn't
matter what your income is.
(10:45):
There's no income limits youcan make Roth 401k contributions
and those contribution limitsare much higher.
So anything that youcontributed to the Roth 401k and
any growth on those Roth 401kcontributions, that all rolls
over to a Roth IRA if you'regoing to move that out of your
401k balance.
Here's a tricky piece.
A lot of 401ks offer what arecalled after-tax contributions.
If you make an after-taxcontribution, you're not getting
(11:09):
a deduction on thatcontribution.
So any dollars that youcontribute to that, that dollar,
that contributed amount, rollsover to a Roth IRA when you
contribute to that, that dollar,that contributed amount, rolls
over to a Roth IRA when you movefrom that company or when you
do that rollover.
But and this is a veryimportant catch any growth on
those after-tax contributions,that's all considered pre-tax
and that would all roll over toyour pre-tax IRA.
(11:32):
Here's why that's so important.
If you have after-taxcontributions that you're making
and if your plan allows forin-plan conversions, what you
want to do is convert thoseassets to your Roth 401k.
It doesn't cost you anything intaxes, assuming you do it
immediately.
So, for example, I make a$10,000 after-tax contribution
(11:52):
to my 401k, I don't get adeduction.
That's why that $10,000 couldmove to my Roth IRA when I roll
it over.
But if I keep it in theafter-tax balance, any growth on
that is pre-tax Pre-tax,meaning when I do pull it out it
will be taxable.
But if, instead, I make that$10,000 contribution, I then
convert it to my Roth 401k,there's no taxes on that
(12:15):
conversion because I didn't geta deduction when I made the
contribution.
Therefore it's not taxable.
When I convert it, I've alreadypaid my taxes.
The difference is now anyfuture growth on that balance is
going to be tax-free becauseit's happening in my Roth.
It's not happening in theafter-tax balance.
So that single decision couldbe something that saves you
thousands and thousands and tensof thousands of dollars over
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the course of your retirement.
Because let's assume I makethat $10,000 contribution and I
let this thing ride for a longtime and it grows to $30,000.
If I had not converted it, that$20,000 of growth is now all
taxable to me when I doultimately take it out and start
spending it.
Versus I simply done thatconversion, that $20,000 would
be completely tax-free.
(12:55):
So very important thing to notewhen it comes to distributing
funds from your 401k into yourIRA and the things that you can
do in the meantime to make surethat you're optimizing the
taxation of those contributions.
Another very important detailfor people that have 401ks and
have company stock in their 401kis you need to consider net
unrealized appreciation as apotential strategy here.
(13:16):
So net unrealized appreciationyou'll see it abbreviated as NUA
.
What that means is you areeligible for preferential tax
treatment on any of the gainsthat you've realized on the
purchase of that company stock.
For example, let's assume thatyou've put in $50,000 to your
401k specifically towards yourcompany stock and your company's
(13:37):
done tremendously well, so that$50,000 is now worth $500,000.
Well, if you were to roll thatall over to an IRA, that
$500,000, once you start pullingit out is completely taxable,
and it's taxable at ordinaryincome rates.
Ordinary income rates are thehigher rates that you're going
to pay.
What net unrealized appreciationwould allow you to do is, it
would say, take that $500,000that's in your company stock,
(13:58):
and there's some details here.
So work with your financialadvisor, work with your
accountant to make sure thatyou're doing this the right way.
But that $50,000, when you takeit out, might be subject, or
would be subject, to ordinaryincome taxes, but the gains on
that, the $450,000 of gains,that would be subject to capital
gains treatment.
Now there are some planningstrategies here, because that
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tax hit is immediate, whereasyou're rolling over a 401k or
rolling over a balance that canbe deferred, that can be spread
out over time.
But make sure that you do theanalysis to see if that would be
a good strategy for you,because that can potentially be
worth tens of thousands ofdollars or more, depending upon
how much you have in companystock and depending upon your
tax bracket.
And then the final thing to notehere, just reiterating what we
talked about before is if youhave an IRA, there's going to be
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a 10% early distributionpenalty anytime you take funds
before age 59 and a half.
Time you take funds before age59 and a half, there's a couple
of exceptions first time homebuyer, if there's a disability,
medical things like that but ingeneral, 10% early distribution
penalty if you take funds before59 and a half.
With the 401k, that age dropsto 55.
You have to have worked at thecompany that is holding the 401k
(15:04):
up until the year in which youturn 55.
But if you do so, that's a fourand a half year difference in
terms of how long you need towait to avoid that early
distribution penalty.
So when should you use a 401k?
When should you use an IRA?
Generally speaking, if you havea 401k with low cost, great
investment options, you mightneed access to the funds before
age 59 and a half.
You don't need a tremendousamount of flexibility in terms
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of trading, conversions etc.
401k might be the best optionfor you.
If that's not the case, if youdon't have great investment
options, if the cost is quitehigh, if you do want more
flexibility or ease of use orcontrol and you don't need those
funds before 59 and a half.
Generally speaking, it might bebest to consider an IRA for
situations like that, so there'spros and cons to both.
(15:46):
Understanding what's mostrelevant to you is the most
important thing to determiningwhether you should use the 401k
or the IRA as you approach yourretirement.
Once again, I'm James Canole,founder of Root Financial, and
(16:07):
if you're interested in seeinghow we help our clients at Root
Financial get the most out oflife with their money, be sure
to visit us atwwwrootfinancialpartnerscom.
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