Today’s workers will likely switch jobs many times over the course of their working lives. This gives rise to a number of old 401(k) accounts to deal with. Left unmanaged these accounts can amount to an unorganized and inefficient investment mess that is likely hindering their retirement accumulation efforts. One of the first things a good financial advisor should do with a new client is to help them get their arms around all of their retirement assets which today is likely to include several old 401(k) plans and other defined contribution plans such as a 457 or 403(b).
When Clients Leave a Job
Clients always want to know what to do with their 401(k) account when they leave an employer for whatever reason. The three options are to leave the money with the old employer, roll it over to the plan of their new employer (if applicable and allowed) or to roll it into an individual retirement account (IRA). The fourth option is cashing it out but this is generally not a good option due to the tax consequences. (For more, see: 401(k) Risks Advisors Should Know About.)
A client might be best off leaving their 401(k) balance with their old employer if the plan is full of solid, low cost options. Larger employers often have plans that carry ultra-low cost institutional investment options that can’t be duplicated at most IRA custodians.
Additional advantages to leaving their money in an old 401(k) plan versus rolling to an IRA might also include:
- Broader credit protection than with an IRA. This might be a consideration for those in professions prone to lawsuits such as doctors in certain specialties. Workplace retirement plans generally offer of level of protection from bankruptcy and lawsuits, though in some states IRA accounts may offer similar protection. Certainly consult with an attorney if this is a consideration.
- Access to penalty-free withdrawals if a client leaves their job in or after the year they turn 55 and expect to start taking withdrawals before reaching age 59 ½. (For more, see: Ways to Cut 401(k) Expenses.)
The same thought process might come into play if their new employer’s plan is like the one described above. Additionally this might be a good way to consolidate the old money with the new contributions the client will be making, eliminating one old account to be tracked. Some additional benefits include:
- Rolling to a new employer’s plan may allow them to defer required minimum distributions on the balance if they are still working and have reached age 70 ½ though you will need to check on the rules for the employer’s plan.
- Ability to take a loan if allowed by the plan. (For more, see: How to Include ETFs in a Client's 401(k).)
Certainly rolling the balance to an IRA can be an excellent idea. The advantages could include the opportunity to consolidate this and perhaps other retirement accounts, invest the client’s money in accordance with their financial plan and perhaps access to a wider array of investment options.
For those clients who leave an employer and hold company stock in their 401(k) plan there is an option called net unrealized appreciation (NUA) that should be considered. The entire balance in the client’s 401(k) account would need to be distributed in the same calendar year. The non-company stock portion would be rolled to another tax-deferred account like an IRA, with the company stock rolled to a taxable account. The client would pay income tax immediately on the cost of the stock at their ordinary income tax rate, but the tax on any capital gains would be taxed at the generally lower capital gains tax rate. (For more, see: 5 Vital Questions Advisors Should Ask New Clients.)
The advantage to a client could be enormous depending upon a number of factors including the client’s current tax rate and the level of appreciation in the company shares. Analysis of this type is beyond the scope of many investors and represents an area for a qualified financial advisor to add value to their clients. (For more, see: Advisors: Tips for Providing for Older Clients.)
Clients often have questions when leaving a job, whether this is the result of a job loss, retirement or changing jobs or careers. Invariably these questions include what to do with their 401(k) or other retirement account. As their financial advisor you can guide your clients through the decision process and help them make the right decision. You can help them assess the merits of their old plan versus their new employer’s plan if applicable. You can also help them determine if it makes more sense to roll their 401(k) to an IRA.
Additionally you would be privy to helping them through any special aspects to their situation such as the need for withdrawals prior to age 59 ½ or dealing with company stock in their plan. Often clients will seek out the services of a financial advisor due to a rollover decision with a 401(k). This is a great area for financial advisors to specialize in as it can lead to long-term client relationships. (For more, see: New 2015 Contribution Limits: Advisors Take Heed.)
It is easy to make a mistake doing a rollover to an IRA that can result in costly tax consequences. As an advisor you can walk your clients through the process and help them avoid these missteps. Most importantly as their financial advisor you can help the client view their old 401(k) in the context of their broad financial picture and advise them on what to do in this context.
The Bottom Line
Many workers will switch jobs several times over their career. This means they will have several old 401(k)s to manage. Multiply this scenario by two for a married couple. Neglecting these accounts can be costly to clients in terms of building their retirement savings. A qualified financial advisor can really add value to their clients by providing them the advice they need in managing these accounts. (For more, see: The Impact of 401(k) Outflows on Advisors.)