The pros and cons of rolling over a client’s 401(k)

Having all of a client’s retirement funds under one roof makes a lot of sense for advisors who want to do the best they can for that client’s retirement outcome. But the pros and cons of rolling over 401(k)s can get complicated. 

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The decision often depends on many factors, including a client’s individual situation, as well as the way 401(k) plan administrators handle the rollover process. 

One complication can arise when clients have to withdraw their 401(k) funds, wait to receive a paper check in the mail and then deposit those funds within 60 days at the new institution. Missing deadlines can lead to a 10% early-withdrawal penalty. Clients might even have to get a medallion signature guarantee, a notary-like process, for the transactions.

“A lot of these are really big checks, so there is a really big sense of urgency,” Tyler End, CEO and co-founder of Retirable, a retirement planning company, told Financial Planning. “If you’re dealing with clients who may be averse or avoidant when thinking or working on their finances, and that check sits for a little too long, it can start to get scary.”

Regulators have strict compliance requirements related to rollovers, including mandating that advisors give sufficient documentation on their recommendations.

“They do make it somewhat difficult, but they also don’t want people to lose out on these tax-advantaged accounts or make the wrong decisions with their money, so it makes sense to have a little bit of a slowdown there and not [be] completely frictionless moving money around,” End said.

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Reasons to roll over 401(k)s

Consolidating accounts can be helpful for clients who want to see all of their retirement funds in one place and more easily understand their asset allocation collectively, Anqi Chen, associate director of savings and household finance at the Center for Retirement Research at Boston College, told Financial Planning.

IRAs have many more investment possibilities than 401(k)s, which tend to have limited options, noted Andy Panko, founder and Financial Planner at Metuchen, New Jersey-based Tenon Financial.

Panko added that IRAs don’t have restrictions on distributions, and consolidating accounts simplifies the process of calculating and taking required minimum distributions.

Clients who are at least 70½ years old can make charitable donations directly from their IRAs to charities, and those donations aren’t taxable and aren’t part of gross income, Panko said.

If there is a small amount of money in the 401(k) account, clients should beware that their money might have been moved and put in a default investment account, End said.

Rolling over could be an opportunity to reassess and adjust investment choices. If clients weren’t actively managing their 401(k)s, the investments might not be optimal.

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Disadvantages of rolling over 401(k)s

If clients roll over their 401(k)s, they will lose the ability to take out loans from the account, a feature that might matter to some clients. Loans aren’t an option once funds are rolled into an IRA..

Rollovers can also be complicated when a client owns a former employer’s stock in their 401(k) and has net unrealized appreciation (NUA).

“You don’t want to just blindly roll the entire 401(k) over to an IRA,” Panko said in an interview. “If you do, and there’s employer stock in that 401(k), and it’s highly appreciated … once you roll to an IRA, it’s gone. The NUA ship has sailed.”

Fees might be higher or lower in an IRA than in a 401(k), depending on which investments clients choose. But all fees being equal, an IRA would have an advantage because it wouldn’t have the administrative fees associated with a 401(k).

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“For me, it’s a client-by-client conversation because it all comes back to what’s in their financial plan, how is it written and what do we need to do to get them where they’re trying to go,” Dale L. Shafer, founder, financial advisor, and chief compliance officer of Scottsdale, Arizona-based Life Moves Wealth Management, told Financial Planning.