4 Rules for 401k Rollovers

Let's get started.

Let's get started. with 401ks from three or four different jobs. And they just have them still in the old account, right? So they got the one in the Vanguard account from their Duke job, and they have one in the Fidelity account from their UNC job, and they have another one on a TD Ameritrade platform from some other place that they worked, and now they're working somewhere else where they have a different 401k.

They have all these different platforms, they're all over the place, and they're a little bit disorganized. Which seems really odd to me because I, in past experience, wanted to disassociate myself as fast as possible with that previous employer, whether for egregious reasons or not. Just, I moved on to a new chapter of my life, it just seemed logical to take that stuff with me, so I find it surprising that it's a common problem. Yeah, but I mean, it's not like the old employer has your money, it's on Fidelity's platform. So, you know, for a lot of people it's just, yeah, I should probably roll that over eventually, but they just never get around to it, right?

That's the most common thing. So the reason you would generally want to move it, and there are exceptions to this, which I'm guessing we'll talk about later, but in general, the reason you'd want to take your money with you is because of flexibility and control. Most 401k platforms have a very limited menu of investment options for you. It might be 10 or 12 in some, it might be 50 or 60 different funds that you can choose from, and some of the more diverse platforms. But the bottom line is, you still don't have the capability of taking advantage of the entire investment world when you're limited in your options. So flexibility and control are really much more at your fingertips when you move that money to your own IRA. And it's also helpful just for organizational purposes, because when you have all these other accounts out there and you end up with five, six, seven tax-deferred accounts, it's really hard to organize and be sure that everything's doing what it needs to be doing. But if you start to consolidate and take those three old 401ks and put them into one account, well then it's much easier to watch and be sure it's all doing what it's supposed to be doing. All right, so that's rule number one.

When you leave the company, your money should leave with you. Rule number two, contrary to what you might think, is not always follow rule number one. It's that there are exceptions to rule number one. And there could be a number of exceptions, but I'm going to give you two specific reasons why you might not want to roll over your 401k. Scenario number one would be if you worked for the state of North Carolina and you had at least five years of service under your belt prior to the year 1989.

Now, I realize we're talking to a very small sector of the people listening to this, but it's important to illustrate the concept. So if you started working for the state of North Carolina in 1984 or earlier, you would have had those five years of service by 1989. And you would be part of the Bailey settlement. You may have heard of Bailey vesting, or you might have heard somebody say, I'm Bailey vested with my 401k. What that simply means is that everybody that has that Bailey vesting does not have to pay state income tax on money that they withdraw from their 401k. If you roll that money to an IRA, all bets are off. Now it's going to be taxed as income, both federally and at the state level, just as it would be in any other IRA. So it's not necessarily a huge benefit since state taxes aren't a ridiculously high rate. You know, it's around 5% depending on exactly where you fall on the tax table there. But that 5% that you're not paying in state taxes is certainly worth keeping it in the 401k in most cases. Now there might be scenarios where you really want to invest in a way that you just can't within the 401k. And so you would still roll it out and say, it's all right.

That 5% is not that big a deal to me. But it's important to understand that that's a scenario where it might make sense to not roll it over. Another example would be, let's say you've left the company at age 56 and you're not sure what you're going to be doing work wise moving forward. Well, if you roll that money to an IRA, you can't touch it until you're 59 and a half. Otherwise you'll have to pay a penalty to the federal government to take an early withdrawal from that IRA. However, if you leave the money in the 401k, as long as you're at least 55, you can take the money out without penalty. So that's one of these weird little rules where if you separate from the company between 55 and 59 and a half, it could very well make sense for you to keep money there in the 401k.

So just a couple of specific exceptions to the rule of you should always take your money with you. So if you've either been a state employee for a really, really long time, or at least had those five years of service before 1989, or you might need to tap into those funds, those should be the alarm bells that go off in your head when a rollover might not be the right case for you. All right, number three, if possible, utilizing a trustee to trustee transfer is going to be best. Yeah, so sometimes your 401k won't allow this, but most of the time they will, which is simply saying, let's pretend like you have a 401k and it's at Valik.

Let's say it's the custodian, that's where you log in, that's where you can look at all your accounts. And let's say you're rolling it to an IRA that is at Fidelity. In an ideal world, Valik would make the check directly to Fidelity for benefit of Walter Storhold, is what it would say on the check.

Fidelity Investments, FBO, Walter Storhold. That check then goes to Fidelity, they deposit it, you never actually had possession of the money. If that's the case, it's much easier and cleaner and you don't have to worry about any deadlines or anything like that. It just goes from one trustee to the other. No tax implications at all. If, and sometimes your 401k provider will only do it this way, sometimes they'll only make the check to you, not to Fidelity, they'll make it to Walter Storhold. And you suddenly have $273,000 that you have to go deposit in the bank.

I'll take it. And then you have to turn around and write a check for $273,000 to Fidelity. As long as you do that and it gets all done and processed within 60 days, you have no tax implications. The problem of course is if something happens and that whole transaction doesn't happen in 60 days from the time you deposit the check to the time the money gets taken to the new account, now it's suddenly considered an IRA or a 401k withdrawal. So now you're going to be taxed and assuming you're under 59 and a half, you're going to be penalized on that money. So usually the 60 day window is a gracious plenty to make that happen. But if you can just do trustee to trustee, it makes it a lot easier and you don't have to worry about it. Can someone use that opportunity when you're rolling over and that scenario where they write you the check and then you write the check in the next step to the new IRA holder, can you take that opportunity to borrow a little money from the 401k or say, all right, well, $273,000, I'm going to keep 3,000 of this and take a trip to the beach. Yeah, so you would then be taxed and penalized on that 3,000 that you're keeping.

So your vacation is $4,000 instead of 3,000. Pretty much, yeah, but yes, you could do that. Okay, so just keep that in mind.

All right, very good. Last but not least, rule number four, roll over with a purpose. And this is not like a dog instruction, but you know, not that kind of roll over.

But you want your dog also to roll over with a purpose and normally they do if they're well trained. So basically the point here is you don't want to just roll to an IRA and then plop it in there and say, okay, now what? Right, you want to have a strategy for what you're going to do with that money once you roll it to an IRA. So I've seen a lot of people roll money from a 401k and if they have the opportunity to go trustee to trustee and they don't even have to cash out, they can just move it over in kind. Like let's say your 401k is at Fidelity and you're rolling it to a Fidelity IRA, you might not even have to sell whatever mutual funds they have in there. You can just move it over as is to the IRA. And if that's the case, I've actually seen people do that, roll to the IRA and then just leave it in the same funds they had it in in the 401k. Well, that rollover did you no good.

You're not taking advantage of that flexibility and control that we just talked about a few moments earlier. I've seen people liquidate what they have, roll it out, park it in a money market in the IRA until they decide what they want to do with it and then two years goes by and it's still been sitting in that money market the whole time because you never got around to deciding, all right, well now that I'm on this new platform, how do I invest? So before the money gets in there or as the money is coming into the IRA, you want to be mapping out your strategy. What am I doing with this money? Is this money that I need for income and the relatively near future or is this money that I'm going to invest and leave alone for a couple of decades because I don't need it for a while? That's going to dictate the investment strategy but that's something you want to decide prior to the money sitting there collecting dust for 18 months. So there you go, the four rules for 401k rollovers.

When you leave the company, your money should leave with you. There are exceptions to rule number one, that's rule number two. And number three, when possible, do a trustee to trustee transfer.

That's going to be usually the best option and cleanest. And number four, roll over with a purpose. Good boy, right? Absolutely, you can get a biscuit.

You get a biscuit, there you go. Thanks John, we appreciate it. Always a pleasure. Helpful tools and resources as always here on Mr. Stillman's Opus. Thanks for joining us on the podcast. For John, I'm Walter, we'll talk to you again soon.