Ep. 2 - Head-to-Head Battle of the IRA vs 401k

John Bever |

One of the key decisions you need to make in the year you retire is what to do with the money in your 401(k).  In this episode hosts John Bever and Jim Uren bring you the epic battle of the IRA versus the 401k. Do you leave all of your hard earned money in the 401(k)?  Or do you move it into an IRA? Hold on to your seats as we unveil the thrilling pros and cons of each option. And be sure to listen until the end to discover the special circumstances that, if they apply to you, will help you avoid potentially costly mistakes. 

In this episode, you’ll be able to:

  • Discover all of the options you can make with your 401(k) in the year you retire
  • Uncover the potential advantages of rolling over your 401(k) into an IRA and discover why so many people make this choice.
  • Learn the situations in which you should not do an IRA rollover
  • Understand the benefits of pre-tax and after-tax contributions for optimizing your retirement funds.
  •  Explore in-service rollovers for flexibility in managing your retirement investments.
  •  Learn about the potential tax benefits of net unrealized appreciation and how it can impact your retirement funds.

The key moments in this episode are:

00:00:05 - Introduction to Retirement Planning
00:01:24 - Special Circumstances for IRA Rollover
00:03:23 - History and Significance of IRAs and 401Ks
00:06:18 - Options for Handling 401K in Retirement
00:08:03 - Pros and Cons of Transferring 401K to Another Employer Plan
00:15:16 - Retirement Account Withdrawal Rules
00:16:50 - Advantages of an IRA
00:19:36 - Roth Conversion
00:21:34 - Roth Conversion Timing
00:22:43 - Consolidating Accounts and Beneficiary Considerations
00:29:15 - Restrictions on 401(k) Withdrawals
00:29:50 - Rolling After-Tax Contributions to a Roth IRA
00:31:11 - Taxation of After-Tax Contributions
00:32:24 - In-Service Rollovers
00:34:06 - Net Unrealized Appreciation

Discussed on This Episode:

Pew Survey on IRA Rollovers – https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2021/09/pew-survey-explores-consumer-trend-to-roll-over-workplace-savings-into-ira-plans

The Johnson Companies 401(k) History – https://jkj.com/about-2/

Employee Benefits Research Institute’s History of 401(k) Plans: An Update – https://www.ebri.org/content/history-of-401(k)-plans-an-update

Investment Company Institute – https://www.ici.org/news-release/23-role-of-iras



Should I Rollover My 401(k)


Show Transcript

Jim Uren: This is The Year You Retire podcast for people who want their first year of retirement to be right on the money. Your hosts are me, Jim Uren and John Bever, CERTIFIED FINANCIAL PLANNER™ professionals with Phase 3 Advisory Services. Retirement is one of the happiest times of life, but getting the most out of it requires you to be properly prepared.

Listen along as we explore the financial topics, tips, and strategies that will help you make your first year of retirement your best year yet. Now let's get planning.

This is the year you Retire Podcast for people who want their first year of retirement to be right on the money. We're hosted by me, Jim Uren and John Bever, CERTIFIED FINANCIAL PLANNER™ professionals with Phase 3 Advisory Services. Be sure to listen to the end of this episode for important disclosure information.

In this episode, we're gonna discuss the IRA versus the 401k. One of the key decisions you need to make in the year you retire is what to do with your 401k or similar retirement plan at your now former place of employment.  Should you leave your money inside the 401k or should you roll it over into your own IRA?

We'll discuss the pros and the cons of both options and we'll discuss some other options you have as well.  And we'll discuss some special circumstances that you need to be aware of because if these special situations apply to you, it could definitely make it much better to either move toward doing an IRA rollover or keeping your money in the 401k.  But first we're gonna touch base with some history lessons in just a moment.

How are you today, John?

John Bever: I am doing very well. And how about yourself? Looks like you're doing great today.

Jim Uren: Doing very well.

John Bever: One of your favorite topics, isn't it? Talking about the 401k versus the IRA.

Jim Uren: Yes, absolutely. And this is a decision that just about every single person needs to make, certainly at retirement and often, many times in our careers as we switch jobs. So it's applicable to everybody, but it's particularly important in that year you retire. So John, here's a trivia question for you and our listeners.

In what year was the IRA created by the tax code? Was it 1974? 1984, or 1994?

John Bever: Okay, so I can target this one because I remember my dad, talking with him about an IRA my first year in the industry. So that was before 1984. So I'm gonna go with 1974.

Jim Uren: That is correct. Yes. In 1974, president Gerald Ford signed the Employee Retirement Income Security Act, which of course created the IRA.  And apparently at that time you could only contribute $1,500. Now, of course, today in 2023 you can do $6,500 and if you're 50 or older, you can actually throw on another $1,000 as well.

So that number has gone up quite a bit. And here's the next trivia question for our listeners. I know that you and I know this one, John, but what does the “IRA” stand for? Hint, it's not what you think. And of course, it's most often assumed to be an “Individual Retirement Account,” but actually in the tax code, it is the “Individual Retirement Arrangement.”

So now according to the Investment Company Institute, there are now eleven and a half trillion dollars in IRA plans across the us. John, can you believe that?

John Bever: That's a lot of money.

Jim Uren: That is an awful lot of money. And that leads us to our next trivia question. In what year was the first 401k offered? Was it 1961, 1971, or 1981? Any guesses, John?

John Bever: All right. I'm gonna go with 1981.

Jim Uren: 1981. That is correct. This one's a little bit more interesting because this was a little bit unintentional. So there was a revenue act in 1978, which was signed by then President Jimmy Carter. And that included a provision that allowed a new way for employees to defer tax on some of their compensation.

Now that provision became part of the internal revenue code 401k, which is, of course, how the retirement plan got its name. And we've not come up with any better terminology since then. And now these new rules, so they went into effect actually a few years later. And the first company to actually offer a 401k to their employees was called at that time the Johnson Companies.

Now, this company today is now, I believe, known as Johnson, Kendall and Johnson. But back then, it was actually led by a guy named Ted Benna who saw the opportunity that this revenue act of 1978 provided. And he was an early advocate for companies to take advantage of this new tax law. And he is now known actually as the “Father of the 401k.”

And of course, the 401k took off like a rocket. And within a couple years, half of all large companies in the US had either started a plan or were considering offering one. And so once this idea came out, it spread like wildfire. And now according to the Investment Company Institute, there’s an estimated $9.3 trillion in defined contribution plans in the US, which would include 401k and similar type plans.

So still a little bit more money in IRAs, but the 401k plan has pretty much almost caught up. So that is a little bit of our history lesson, John, of how we got here between the IRA and the 401k.

John Bever: Well, I think that $20 trillion between those two different ones is starting to sound like some real money there. You know what? I thought the father of the 401k was actually Uncle Sam, but I guess not. So Ted Benna.

Jim Uren: That's right. Yep.

John Bever: I know that they have made lots of changes and tweaks to the laws.  But the bottom line is, what do we need to know about setting up a 401k and especially how to handle that in the year that we actually retire? What are our options for accessing that money, Jim?

Jim Uren: Good question. So these are the main options that people have. So when you are retired, you're done with your job, you've got typically four main options.

The first is what we call a “lump sum payout.”

The second is you can transfer it to another employer plan, which typically doesn't apply if you're retiring, but that is an option if you're still working and looking to move to another job, maybe part-time.

Third, you can certainly leave the money in the 401k. That's not always an option (particularly if you have a balance under 5,000), but that's certainly an option for most folks.

And your fourth main option, of course, is you can roll that over into an IRA.  And that, believe it or not, can actually sometimes be done while you're still an employee at the company.  So we'll touch base on that. So how about we go through each option, John?

John Bever: Sounds good. Let's go.

Jim Uren: All right, so option #1: lump sum payout. And this is exactly what it sounds like when you retire. You could just say, send me a check for all my money in the 401k. They certainly will do that. Typically, as long as you're over 59 ½ there's no tax penalties, but of course you would have to pay ordinary income tax on any lump sum distribution. And this usually would result in an absolute tax nightmare. And so it is recommended almost in every case, that you avoid this at all costs. Few people do this upon entering retirement for obvious reasons. It does it does drain a ton of the money, but that's an option.

All right, let's look at the second option: You can transfer into another employer's plan.  Again, if you're gonna be starting a part-time job, or maybe you're not quite actually at that year you retire. But typically, you can take your 401k and transfer it into the 401k of another employer.

Some of the same pros and cons apply to this strategy that we're gonna discuss in a bit in terms of 401ks versus IRAs. The one advantage of this can be that a 401k does allow you to take out a loan against the 401k in most cases. It does vary by plan, but typically the employer allows you to borrow money.

You can borrow up to half the value of the account not to exceed a loan of $50,000. So theoretically, if you're just starting a new job, you don't have any money in that 401k.  By transferring your 401k from a previous job into your new 401k that does leave the door open for you to borrow against that 401k.  So that is one thing to consider.

Now, option three, of course, is you can leave your money in your 401k. You're not required in most cases to do anything with that money in the 401k when you leave that employer, either because you're switching jobs, or in our case today because you're retiring now.

There's some advantages to doing so. One, of course, the first one, is that it's the easiest option. There's nothing you've gotta do. It's the path of least resistance. And so no effort needed. Second sometimes the 401k does provide some low cost investment options, especially if you're at a very large company.

Typically, the larger the employer, the lower the cost of the plan born by each individual employee because they've obviously got a lot of bargaining power when they approach financial institutions to help them run these plans. So, sometimes you can get a lower cost investment option. Another advantage is that in a 401k, unlike an IRA, which in many ways are typically fairly similar, you can make distributions at age 55, if that's when you leave your job.

So if you leave your job after age 55, you can start taking distributions or withdrawals out of that 401k without that normal 10% penalty. So, you know, if you're 58 and you're retiring you may want to leave that money in the 401k. Because if you're gonna be withdrawing that over the next few years, you've got an opportunity to basically reduce your income tax hit, and that's of course worth doing.

Now, another factor to consider, John, is that some states, as you know, do provide a little bit lower asset protection for IRAs versus 401ks.  Now federal law exempts 401k assets from creditors. States though, sometimes follow the federal rules like Illinois, some don't. And so if asset protection, meaning if in the event you're sued, if that's a concern for you, (maybe because you have an occupation that that's more likely) that is something to consider.  You can touch base with your attorney and see if the particular state in which you reside provides less protection for you in an IRA than a 401k. If so, it may make sense to keep your money in the 401k.

Next potential advantage is that, or disadvantage as it may be. You may not be able to roll over your 401k if you have a loan.  So if you have a loan out against your 401k you may not be able to roll out to an IRA, even if you desire to do so. So that's a factor you're gonna want to anticipate.

John Bever: I would recommend everybody check with the employer if they're in that situation, because I've been surprised at a couple of situations where the clients have been able to leave the money and arrange monthly payments

Jim Uren: Which is nice.

John Bever: sorry, leave the 401k loan while they've left the company.

Jim Uren: And that does happen on occasion, and that's nice that when they provide that flexibility.  Not all employers do.

And so that does bring up a good point is that there are kind of general 401k rules the government put in place, but each individual company gets to decide a lot of the details of these rules.  And so it's important that you understand your particular situation.

The other thing that you need to consider if you've got a 401k, is you may not want to roll it over yet, if your 401k holds employer stock inside your plan.

We've got a lot of clients in our area in particular, John, as you know, who hold employer stock in their 401k, and we're gonna talk about this a little bit later in the show.  A strategy called “net unrealized appreciation.” But if you have employer stock in your plan, make sure you listen because there's a strategy that you may want to utilize that can save substantial amount of taxes. And so anyway, that's a factor to consider.

Alright, so here's a tip that as we talked about, you know, some of these individual rules, is getting a copy of your plan summary document.  John, can you tell us a little bit about what that is and how someone might get a copy of that for their 401k?

John Bever: Yes. So it contains all of the provisions of the plan in plain English.  And now that's plain English to those of us in the industry. Not necessarily plain English to everybody on the street. But it's a step away from all the legalese and it can be anywhere from 50, 60 pages to several hundred pages.

The easiest way to get this is to actually go online for your 401k plan and where you find your account statements. And in there you will find a section that contains this summary document. Sometimes it has the acronyms, SPD for summary plan description. If you can't find it, just go ahead and give HR or the planned administrator a call, and they may be able to guide you to the place where you can find that.

Jim Uren: Thank you. Absolutely. And that can be very helpful, especially when you're making this decision because that will lay out some of the options that we're discussing, so, perfect.

All right, onto option #4, rolling your 401k over into an IRA. Now, just as I kind of alluded to before, there's a lot of similarities between a 401k and an IRA, so I think it's helpful to start there.

Both of these options are tax deferred. Meaning that, you know, if your account goes up in value or it pays dividends or interest, you're not actually having to pay any taxes on it yet.  It's when that money is pulled out of the account. So both of these provide tax deferral most of the time. Not all the time, but most of the time we're putting in money on a pre-tax basis.

So, you know, you make a hundred dollars, you put it in that IRA or 401k, you don't have to pay tax on that a hundred dollars that year you earned it. You defer that until, you know, hopefully many years down the road until retirement. Then of course, when you pull it out, you do have to pay tax on it.  Again, that's not always the case, but that's generally how it works for most dollars.

Now, both of these then obviously are taxed when you withdraw the money. Typically for both of these, you're not supposed to take money out until you're 59 ½. If you take it out prior to that, you pay an additional 10% penalty on top of the ordinary income taxes that you have to pay now.

We're not going to get into all the details. There are some exceptions to these rules for IRAs. There's exceptions on 401ks. They're not the same exceptions, so keep that in mind.

And both of these do require minimum distributions.  What we call “RMDs” or required minimum distributions at some later age now.

Right now it's a little bit in flux depending on when you were born, but it's about age 72 to age 75. Bottom line, at some point, uncle Sam says, “Listen, you know, John, we've been patient with you all these years. We let you earn all this money and not pay any tax on it. We're tired of waiting. And so, you know, you're going to have to start taking a certain amount out of that every year so we can get our tax dollars.  And if you don't, we're gonna start charging you a big tax penalty.”

And so, you know, of course you need to comply. So neither the IRA or the 401k allows you really to avoid that one exception. Of course, if you are still working and funding a 401k, typically you are allowed to not do your RMD.

So that is one perk if you're continuing to work that favors the 401k. Alright, so let's hop into some of the advantages of the IRA. The biggest advantage that most people said, of course, is there are far more investment options available to you as the IRA owner because you've. Literally got thousands of options.

And typically your 401k at, at the office, they may have 10 funds, 20 funds, 30 funds maybe that you have to choose from. So you're kind of really limited. And John, I'm sure you can attest to some plans offer great options and some are pretty poor.

John Bever: Yes, it does vary. There's no way to say without looking at the funds themselves, how the plan is gonna function that way. Whether they have good options or poor options, I find for the most part, they tend to be what I would call the plain vanilla options. So nothing too esoteric. Typically pricing is pretty decent, but it does take looking underneath the hood to see each option.

Jim Uren: Absolutely. Yeah. And so you and I do a lot of this all the time, right? We help clients manage their 401kss at work, and so they provide us with the information. We might look over their plan, document, their investment options, and I know you're like me. Sometimes you walk away, go, Hey, they've got some really good options here.

And other times it's like, I don't know what they were thinking when they put this one together, but you know, it is what it is. So, but that is one perk of course of the IRA is that you get to choose how you want to do it. You don't have to stick to the plain vanilla funds. You can find funds that matter, maybe better suit your particular risk tolerance and desire to diversify your portfolio.

Second advantage is you do have typically much broader access to any sort of insurance product. So there are ways that you can use your retirement account to invest in an insurance product. For example, in annuity some 401k plans are offering this, and we're actually gonna start seeing this a little bit more, where you can actually turn all or a portion of your 401k into, essentially it's like a pension.

Where you say, Hey, just take the money, but in return, send me a check every month or every, yeah, every month for the rest of my life. Right now, you've got a lot more ability to do that with an IRA. You're not just limited to whatever the 401k offers. And of course, a lot of 401kss don't even offer it.

So that's one advantage. If, if an insurance products makes sense for you, it doesn't for everybody. But for some people it can be a big a big help. Third advantage is that you may be able to reduce the cost with an IRA rollover. So again, if you're in a 401k, where the, the, the fees are particularly high, you might be able to reduce those fees quite a bit, particularly if you're gonna completely manage things on your own. Another advantage of the 401k is that you can do a Roth conversion. You can sometimes do these within a 401k, but again, it varies. But with an IRA, you may be able to take some of your IRA money. In fact, you can take some of your IRA money and convert it to a Roth IRA. What does that mean?

Well, without getting into a lot of the details, again, we talked about the tax deferral of an IRA. Well, you can take a portion of that and you can convert it to a Roth IRA. That means that you pay tax when you do that conversion. So let's say you're gonna convert $10,000 over to a Roth if you're in a 15% tax bracket, that does mean you'll pay $1,500 in taxes that year.

However, that $10,000 is now in a Roth IRA, and that grows tax free so long as one, you're 59 and a half, and two, you've had the Roth account open for five years. And so for some people that can make a lot of sense to do a Roth conversion between the time they retire and the time they hit their required minimum distributions.

Can you explain John, why that's often the case for a lot of our clients where we do those Roth conversions in those years between retirement and required minimum distribution?

John Bever: Yes. So when they retire, if you're retiring and you're not collecting social security and you're not yet to the age where you have to take a required distribution, your income might be quite low. Maybe you're living on some money that you've set aside short term for a year or two. So you're in a very low bracket, sometimes in a zero bracket, so you can actually extract money out of the pre-tax.

And put it into the post-tax Roth pay tax on that transaction. But you're paying that tax at a lower bracket than when you have all that other income from Social Security and your required minimum distributions, even if you're collecting Social Security, but not to the age where you have to take those minimum distributions, you can still have that option available to you.

Because of the brackets, how they're set up. The brackets are a tiered system and that's quite a bit of the planning that we do in those early retirement years for clients, especially now that they've extended the required minimum distribution age to age 72, 73, and for some people even 75.

Jim Uren: Absolutely. So sometimes it does make sense to pay a little bit tax, a little bit of extra tax now to avoid a lot of tax later.

John Bever: Exactly right. The old Fram commercial. For those of you that are of that age, you can pay me now or pay me later.

Jim Uren: that's right. And you gotta pay. And so part of our job is helping clients figure out, you know, certainly we all like to pay later rather than now, but. We'd rather pay whatever's less, right? So sometimes it makes sense to pay a little now to avoid paying a lot later. And the other perk of the Roth, of course, is that there are no required minimum distributions at any age.

Why? 'cause once the money's in there, as you pull it out, uncle Sam doesn't get to tax it anyway. So they don't, they don't make it take it out since it doesn't give them an advantage. Alright, so another advantage of of rolling over from a 401k to an IRA for some folks is that it just simply helps consolidate accounts.

So nowadays it's not unusual for people to maybe have a couple IRAs, maybe even two or 3, 401kss from former employers. And, you know, frankly, it can just be a lot easier to say, you know what, I'm just gonna put that all in one account. And so I'm not managing, you know, four different logins at four different institutions. Another advantage is it may be better. For your beneficiaries to inherit the IRA funds versus a 401k, not always the case. Again, 401ks are set up a little differently at each company. Some, although they've, they were getting better about this, but certainly in the past, some 401ks do not allow you to kind of take the money out in stages if they force the beneficiary to pull all the money out on the front end.

That could result in major taxes. And so that's something that you want to be aware of, that seems to be addressed in some legislation, but I don't think it's quite taken effect yet. So just something to keep in mind. And of course, the other really big advantage that people cite in rolling over from the 401k to the IRA is access to professional.

Management and advice, and that's typically in your 401k, you're completely on your own. So, you know, historically companies tended to do a lot more of these, what we call defined benefit plans, right? Pension plans. You didn't have to make any decisions. Money was set aside for you and you retired.

They said, Hey, this is the check you're gonna get every month for the rest of your life. Well, they started transitioning to these 401kss, as we talked about, in the early eighties. And companies loved them. Why? Because they knew for sure what their liabilities were, right? That they're called defined contribution plans.

In other words, we're not promising any sort of benefit. We're just gonna give you a contribution. And however it works out, that's, that's your problem. And so, you know, when you're 25 John, and you make a mistake in your 401k, it's not that big of a deal.

John Bever: True.

Jim Uren: When, when you're 65 and retiring, you, you have your whole life savings.

 People start to sweat it out a little bit and go, gee, maybe I, I don't wanna make a mistake at this stage of the game. And so a lot of people are typically looking for some professional advice on that particular account. And that's typically not available in most 401kss, but it is in an IRA.

And so that's the other big thing. Reason people do it. So that's kind of in a nutshell, John, the four major options you have, with your 401k.

John Bever: And you know, when you add those zeros to the plan balance, those decisions become much more important because they are more significant. And that flexibility can be very key, especially in that. Roth conversion option inside the 401k. If you wanna do a Roth conversion, you can't actually identify which fund you wanna convert.

You're gonna take a pro rata portion of the entire balance and do that conversion where if you have the money in your IRA, you actually actually can choose individual positions to convert. So if you have a particular fund or position that has fallen in price but you think is gonna come back, it might be advantageous to convert that one position. So my question for you, Jim, what do you find most people do?

Jim Uren: Good question, and of course we've got some research on it. So according to a Pew Research survey of recent retirees about half actually leave their money in their former employer's 401k, about 54% of people, and about half or 46% roll it over to an IRA. So it's about evenly distributed.

John Bever: So what are some other things that people should consider when deciding what to do with that 401k?

Jim Uren: So another, another thing to consider is that the required minimum distribution. So as of right now, Roth, IRA accounts historically have still required you in a, in a 401k, you can have a Roth account in a 401k. As you kind of alluded to earlier, John, historically, You still had to pull money outta that account.

Now that has changed, but that's not changing until next year. So, you know, if, if you happen to be in that small window of people that's gonna have to pull money out of a Roth 401k that you don't need or want a IRA rollover certainly makes sense.

John Bever: So lemme clarify that. So in 2023, if I have to take an R m D outta my 401k and I have a Roth balance, I have to take an R M D on the Roth. But next year, 2024 in that same 401k I won't have to.

Jim Uren: Exactly. So if you don't wanna do that this year, a 401k rollover may make sense because you can roll over your Roth portion of your 401k into a Roth IRA once it's in the Roth. IRA, as we said already, there's no required minimum distribution, and that's what we often see happening, right John?

Because people save most of their money in these IRAs and 401ks, and it's pretty common. When you hit those older ages where they force you to pull money out, that you're often forced to pull out more than they actually need to

John Bever: Yes. Yes,

Jim Uren: And so people find that a little frustrating 'cause they see their tax bill jump up even though they didn't wanna pull the money out.

Uncle Sam said, you're taking it out and so, We've gotta come up with strategies to help address that. After-tax contributions are another factor you want to think about. One nice thing in these 401ks, some of these 401k plans offer an after-tax contribution option. John, can you explain what that means?

What is an after-tax contribution?

John Bever: Yeah, so there are actually three types of contributions that you, the employee can put into your 401k. The first one is a traditional pre-tax. We're all familiar with those. You put money in, it's on your pay, but it doesn't show up as taxable income on your W two. You're not taxed on that until you take the money out.

The second one is a Roth contribution. It's treated in a Roth fashion, meaning that you put after tax money into the account, but it grows tax free. And if you meet those requirements that Jim mentioned earlier then you can pull that money out on a tax-free basis over the age of 59 and a half. The third contribution that you, the employee can put in is a voluntary after tax contribution.

It's voluntary, meaning that you can put it in and take the money out at will. You don't have any restrictions on that other than the plan might say, well, you're only allowed one withdrawal a year, or something like that. But it's money in, money out, no penalties. You don't get a tax break. It's after tax contribution, but the money that's earned in there.

What's really nice about this, you don't pay tax on that earned money. Until you pull the money out, you can roll that balance from your voluntary after tax account to your own Roth IRA. Anytime you want to, again, depending on how the plan allows you to move money out of the plan itself. And so the beauty of this is that you can build up additional money that you can then roll into your Roth IRA and some plan providers actually allow you to move just your contributions, which wouldn't be taxed at all.

You could include your gains. Which would be taxable, but then it's in the Roth IRA and grows tax free for the rest of your life. So it's a really nice option, especially for those clients that have either maxed their Roth IRAs and wanna put more money in, or those that are not eligible to fund a Roth I a because of income restrictions.

Jim Uren: Excellent. And, and not every plan allows those. Right. So we talked those three, those three things you mentioned. The first was the, the pre-tax contribution. They all allow that. Every plan allows that. That's the point of it. Not every plan allows a Roth contribution, though. We're seeing a lot more of that. Which is great. And then some offer this after tax contribution, which can be really powerful. Like you said, John, particularly for those folks who you are approaching retirement and can actually save a lot more than even the, the maximum, the 401k allows. It's another way to put money in. And so if you've got after-tax contribution That money sometimes, depending on the employer, you'll still pay tax on the gain of that after-tax contribution in some cases.


John Bever: That is absolutely correct. So the gain on the after tech contribution is taxable. As it's removed stays in the plan. It won't be, you can also roll some planned administrators, allow the rollover of the taxable portion to your IRA. You can continue to defer paying the tax until a later date. But again, it does, depend on each plan administrator.

And, you know, it's a, a way that you can find out if this is available to you or not is in that summary plan description. And if you don't have it available, certainly bug HR about it because the squeaky wheel does get the grease. And we find more and more companies are adding this in as the requests come in.

Jim Uren: Yes. And so if you have this after tax contribution portion of your 401k, It can make sense to roll that over as soon as possible to a Roth so that future earnings of that money are tax free. And so that's the special circumstance here. If that's your case, it may make it more likely that you want to do the 401k to IRA rollover as opposed to leaving the 401k 'cause it could potentially save you a lot of tax dollars later on in retirement.

John Bever: That's correct.

Jim Uren: All right. Another special circumstance is what we call in-service rollovers. Again, not applicable so much if this is the year you're gonna retire, but if you're approaching that year, some plans, and again, look at your plan document, allow what are called in-service rollovers. John, can you explain what an in-service rollover is?

John Bever: So you are in service. You are still with the employer, but you're able to roll that money over, and it's a really nice advantage. I'm working on a case right now with someone that has a complicated situation. They are going to be retiring sometime in the next couple of years, but are going to need some money to start a business and other issues.

And so this in-service rollover gives them some flexibility while still leaving a portion of the balance with the company in the 401k. And so that's the in-service rollover. You are in service, you're with the company, but you can still roll a portion to your own IRA. And again, this is separate from the voluntary after-tax rollover that we just discussed.

This would be a rollover of your existing pre-tax balance or Roth balance, or both in your 401k.

Jim Uren: Absolutely. And the same, pretty much pros and cons apply that we've been talking about. So if more of the, the advantage of the IRA appeals to you, you can check and see if you're allowed to do these in-service rollovers and they vary by company. I've seen some with, you can basically do it any time, a lot of them that do allow it.

You might have to reach a certain age, maybe 55, 55 and a half and some simply don't allow it. But it's worth checking if the IRA. Is more appealing to you than the 401k. The last thing I want to talk about, we alluded to earlier, but it's something called the net unrealized depreciation. A lot of even CPAs that I've talked to are unfamiliar with this, but again, if you have company stock in your 401k so you work for, you know, a b, C company and as part of the 401k, maybe you've got 10% in a, b, c stock and you've been, you know, investing in that for 20 or 30 years.

Net unrealized appreciation is a strategy that allows you to withdraw the shares of stock from the 401k and to pay tax on what's called the cost basis rather than the market value. So again, if you were gonna withdraw a hundred thousand dollars of your company stock from your 401k normally, You would pay tax on a hundred thousand dollars of income, but if over the course of your career you've only actually invested $50,000 into that a hundred thousand dollars worth of stock because it's now grown, when you withdraw those shares, uncle Sam's only gonna charge you tax on the $50,000.

Now, that's a big difference in this scenario, right, because I'm pulling out the same dollars, but I'm paying half the tax. And over a long period of time, that could be very advantageous. Now you've got those shares of stocks sitting there. When you go to sell those, you still have to pay a tax on them.

However, it's a capital gain tax and capital gain. Tax rates are lower than ordinary income tax rates, so you pull the money out, you pay some ordinary income tax now, but you can defer. Tax on the gain, but even if you sell the stock immediately, it may still make sense to utilize the strategy because you're still paying at a lower rate than you might otherwise.

So if you've got company stock, bottom line in your 401k before you do anything. You need to look at this net unrealized depreciation strategy to see if this may make sense for you. Sometimes it's not that great. In other cases we've seen we're talking big difference. I'm working on a case right now where we're talking.

I'm projecting, you know, up to even a million dollar difference in terms of net worth over one's lifetime. Based on this strategy, because of the potential tax savings that one could utilize. So be careful if you've got company stock. That's one of those things that you need to really think through and know what you're doing before you make any decisions, because you can screw this one up.

There's a lot very specific steps the i r s requires you to go through to take advantage of this. And so you need to make sure you, you you do that. So,

John Bever: And with that, Jim, if you have this, this option for your plan, But you're not participating in it. It's something that you really should evaluate because there may be an advantage to you again over time to build up that, that company stock portion that can be rolled out with this net unrealized appreciation and is very useful also in filling gap years in retirement.

So those years where you're retiring, before you're collecting social security, or if you have a pension available to you. So a lot of opportunities, a lot of tax planning opportunities with using company stock inside the 401k.

Jim Uren: Absolutely, very helpful strategy should that apply to you Now as we wrap things up, wanna let you know that we do have a flow chart available that can help you make this decision about whether or not to roll over your 401k to an IRA.. So absolutely happy to share that with you.

 You can go right to our website at phase three, advisory.com/. Episode two. You'll have show notes there. We'll have some of the studies we cited here, but we'll also have the ability for you to get a copy of that flow chart so it'll help you kind of walk through some of these decisions that we talked about today. John. That pretty much covers the head-to-head competition of the 401k versus the IRA

John Bever: Yeah, so I wanna know which one won.

Jim Uren: That's a good question. Like everything in our field, right John? It depends. It depends. So. Alright, we like to wrap up every episode by sharing what we are thankful for. John, do you wanna share? What are you thankful for today?

John Bever: Well I am thankful for having an empty nest. Pam and I are doing some work on on the house and doing some work outside. It's just nice to have some of that flexibility. We love to have people in love to have the kids in, but it's also nice to have that quietness at night. When we're done, we're exhausted and we just plop down and fall asleep.

Jim Uren: That is great. I think it'll be a hundred before we hit that stage ourselves, John, but my thankful is similar to that. We've got at least two of our five kids who are, you know, kind of in that adulthood stage and I'm thankful to see that. It's fun to see. I mean, they start out young, you.

You can't even get 'em to wash their hands or brush their teeth. But it's neat to see them enter adulthood and manage career and make decisions that you know, that are, that are good, right, that are wise and make sense. They don't always do everything the way you would, but it's fun to see them start their careers and make good choices and establish their own.

Their own lives. So that's, that's what I'm thankful for today. So thank you all for listening. Again, if you have any questions, always feel free to reach out to us. You can get us on our website and you'll hear the contact information as well a little bit later in our disclosure. But to get show notes and to get a copy of that flow chart, phase three, advisory.com/episode two.

Thank you so much for listening. Bye-bye.

Disclosure: The views expressed in this podcast are not necessarily the opinions of Phase 3 Advisory Services and should not be construed directly or indirectly as an offer to buy or sell any securities or services mentioned herein.  Unless otherwise specified, show guests are not securities licensed or affiliated with Phase 3 Advisory Services or Osaic Wealth.   Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results.

No strategy can assure profit nor protect against loss. Please note that individual situations can vary. Therefore, the information should only be relied upon when coordinated with individual professional advice.  Securities offered through Osaic Wealth, Inc. member FINRA/SIPC.  Additional investment. and insurance advisory services offered through Phase 3 Advisory Services Limited, a Registered Investment Advisor.

Osaic Wealth is separately owned and other entities and or marketing names, products or services referenced here are independent of Osaic Wealth. Phase 3 Advisory Services is located at 1110 West Lake Cook Road, Suite 265 in Buffalo Grove, Illinois 60089. Our phone number is 847-520-5545. For additional information, visit our website at phase3advisory.com.