Today is another article in from the Financial Advisor Blog Sharing Group. This group is made up of other like-minded financial advisors from around the country. The purpose of the group is to share useful content and spread the word about the virtues of Fee-Only Fiduciary financial advice. The next contributor in this series is written by Gregory Johnston of Johnston Investment Counsel from Peoria Illinois. He wrote an article why you might want to roll your IRA back into your 401(k). It sounds counter intuitive but might make sense in some circumstances. Here's the Article:
For many individuals, when they leave an employer, they roll their 401(k) to a rollover IRA (Individual Retirement Account). Often times, this may provide you with broader and better investment choices than leaving the account in your prior-employers 401(k).
Less common, but a potential viable strategy in the right situation, is to do the opposite – roll your IRA back to an employer’s 401(k). This is known as doing a “reverse IRA rollover”. Whether it makes sense for you depends on your unique fact scenario.
Listed below are some advantages / disadvantages that you should consider before rolling your IRA back to an employer’s 401k.
Possible Advantages of Rolling Funds to a 401(k) From an IRA
Roth IRA Contributions / Conversions
After you reach a certain level of income, Roth IRA contributions are not allowed. However, conversions from a traditional IRA to a Roth IRA are allowed for any income level.
If you have monies in a pre-tax IRA account, you will run into complexities and potential tax issues when you do a Roth conversion. The details are beyond the scope of this article.
However, if you roll your traditional (pre-tax) IRA back to your employer’s 401(k), you would no longer have any pre-tax IRA money. This should allow you to make a non-deductible traditional IRA contribution and then convert that contribution to a Roth IRA for essentially no tax cost.
Retiring Later / Avoiding the Required Minimum Distribution Rule
Once you reach 70 ½ and have a traditional IRA, you have to start taking required minimum distributions (RMD) from your account. If you are not working, you also have to take RMD’s from a 401(k) account.
But there is an exception to the 401(k) rule. While you are still working past 70 ½, you are not required to take RMD’s from your current employers 401(k) plan (until you actually retire). If you have 401k accounts at other employers, you would have to take RMD’s from those accounts. To be clear -- the exception only applies to the balance in your current employers 401(k).
If your current employer allows rollovers from previous employers 401k and IRAs, you could eliminate the need to take RMD’s until you actually retire.
Retiring Early / Getting Access to Your IRA Money
401k’s tend to be more flexible compared to an IRA with respect to getting money out of the plan earlier without paying a penalty. Normally, with both a 401(k) and IRA, if you want to take money out before 59 ½ you will have to pay a 10% early withdrawal penalty.
However, many employers allow penalty-free withdrawals starting at age 55 for employees who retire. To take advantage of the penalty-free withdrawals, you have to keep your money in your current employers 401(k) plan.
While it is not required, many employer 401(k) plans allow participant loans (unlike an IRA which never allows loans). This would be another way to possibly receive penalty-free money from your 401(k).
Qualified workplace retirement plans have better creditor protection compared to IRA’s – even if you declare bankruptcy.
Possible Disadvantages of Rolling Funds to a 401(k) From an IRA
Listed below are disadvantages that individuals should be aware of before completing a reverse IRA rollover.
Less Flexibility on Withdrawals
If you are younger than 59 ½ and not retired, there are only specific reasons you can get money out of your workplace 401(k) plan. The 10% early withdrawal penalty would apply in addition to regular income tax.
With an IRA, you can take a distribution at any time for any reason. You, of course, must be prepared to pay the income tax and possible 10% early withdrawal penalty if you are under 59 ½ and do not meet one of the penalty exceptions.
More Limited Investment Options
By using an employers qualified plan, your limited to its menu of investment options. Many times, the available investment options are less extensive than what may be offered via an IRA. Simply make certain you can properly diversify your portfolio.
In a similar vein, particularly for smaller-employer 401(k) plans, the underlying expense ratios and costs associated with the investment options may be significantly higher than investment options in a IRA. Make sure you have a good understanding of all ongoing costs associated with moving money back into a 401(k) plan.
If you are seriously considering doing a reverse IRA rollover, make sure to contact your current employer to see if the plan even allows them – not all plans do. If they do not allow it, then you will not be able to proceed.
But, if the employer does allow it, prior to starting the paperwork, make sure you discuss doing this with your tax and/or financial advisor. Since it may impact your tax return, making sure your advisors are aware of your actions simply makes good sense.
On our website, there are links to a variety of retirement planning information and articles.
About the Author
Gregory A. Johnston, CFA®, CFP®, CPWA®, QPFC, AIF® has over 25 years of investment and comprehensive finanical planning experience. He started Johnston Investment Counsel in 1997 as an independent, fee-only investment management and comprehensive planning firm located in Peoria, Illinois. His clients include individuals, retirement plans, and endowments / foundations.