What Is a Reverse Rollover for Your 401k?
Money Girl explains what a reverse rollover is, who should consider one, and the 10 main pros and cons to keep in mind before pulling the trigger
Listener Michael asks:
“When I left my company last year, I rolled over my old 401k into a traditional IRA. This week, I accepted a new job with a great company that offers a 401k with matching funds. Should I reverse rollover the funds from my IRA into my new 401k when I’m eligible to participate?”
In this episode, I’ll answer Michael’s great question by explaining what a reverse rollover is, who should consider one, and the 10 main pros and cons to keep in mind before pulling the trigger.
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What Is a Retirement Account Rollover?
If you’re a regular Money Girl blog reader or podcast listener, you’ve probably heard of a retirement account rollover. It’s when you withdraw assets or cash from one retirement plan and move some or all of it into another plan.
As long as you complete a rollover within 60 days, it isn’t taxable. But if you miss the deadline, watch out! You’ll have to pay income tax on any amounts that weren’t previously taxed, such as Roth distributions.
Plus, you typically also have to pay a 10% early withdrawal penalty if you’re younger than age 59½, unless you qualify for an exception. I’ll cover some penalty exceptions in a moment.
What Is a Reverse Rollover for Your 401k?
Rollovers are most commonly done after you leave a job and are no longer eligible to participate in the company’s retirement plan, just like what Michael mentioned in his question. Instead of just leaving money with your old employer, you can move it into an IRA that you control.
Doing the opposite – moving money from an IRA into your workplace retirement account – is known as a “reverse rollover.” While retirement plans aren’t required to accept incoming rollovers, many do.
See also: 10 IRA Facts Everyone Should Know
5 Pros of Doing a Reverse Rollover
Whether you should do a reverse rollover depends on whether you’ll get more benefit from having all your money in a workplace plan, or spreading it out between a workplace plan and an IRA.
Retirement accounts come with different rules and benefits. Once you understand the main differences between an IRA and a typical workplace plan, you’ll know what’s best for your situation.
Here are 5 main pros for doing a reverse rollover by moving money from your IRA into a workplace retirement account:
Pro #1: Consolidating Accounts
If you’re like me, the idea of simplifying your financial life makes your heart sing!
If consolidating all or a majority of your retirement investments in a workplace plan will keep you more organized, that’s a terrific benefit. By moving your IRA funds into your 401k or 403b, you can keep an eye on all of your retirement money in one place.
Pro #2: Getting Earlier Withdrawals
If you’re thinking about early retirement, you may be able to get your money out of a workplace plan sooner, with no tax liability, than out of an IRA.
If you’re still working at age 70½, you don’t have to take minimum distributions from your 401k or 403b until you actually retire. So doing a reverse rollover gives you advantages if you want to retire early, or retire late.
Some workplace plans allow you to take penalty-free withdrawals at age 55, instead of having to wait until the official retirement age of 59½. But you have to keep your money in your former employer’s plan to do that.
On the other hand, with an IRA, you can never take penalty-free withdrawals until reaching age 59½.
Pro #3: Retiring Later
But what if you love working for your employer and have no plans to retire early? With a traditional IRA you must begin taking withdrawals and paying tax on required minimum distributions at age 70½, no matter what.
But that’s not the case with a workplace plan. If you’re still working at age 70½, you don’t have to take minimum distributions from your 401k or 403b until you actually retire. So doing a reverse rollover gives you advantages if you want to retire early, or retire late.
Pro #4: Getting Loans
Workplace retirement plans are not required to offer loans to participants, but many do. This is not the case with an IRA, because loans are never allowed.
With a workplace retirement loan, you can typically borrow 50% of your vested account balance, up to $50,000, without paying an early withdrawal penalty (if you’re younger than age 59½.)
However, you still have to pay interest on a loan from your 401k or 403b, which gets added to your account balance. The loan plus interest must generally be repaid within 5 years, or any outstanding balance will be considered an early withdrawal.
See also: Should You Take a 401k Loan?.
Pro #5: More Protection from Creditors
Qualified workplace retirement plans get some nice federal protections that don’t apply to IRAs, thanks to the Employee Retirement Income Security Act of 1974 (ERISA). This law keeps your 401k (and in some cases your 403b) safe from creditors, even if you declare bankruptcy.
There are some protections for IRAs; however, they vary from state to state. For instance, a creditor may be able to seize your IRA depending on your financial situation, and how much is in the account.
See also: 7 Pros and Cons of Investing in a Retirement Plan at Work
5 Cons of Doing a Reverse Rollover
Now let’s cover some disadvantages of doing a reverse rollover. Here are 5 main cons that may tip the scales in favor of leaving your money in an IRA, instead of moving it into a workplace plan:
Con #1: Less Control
With a retirement plan at work you can only make withdrawals when you have a specific qualified hardship, such as needing money to avoid foreclosure or to pay for a funeral. Hardship withdrawals are still subject to the 10% penalty that I previously mentioned.
On the other hand, with an IRA you can take a withdrawal at any time and for any reason, as long as you’re prepared to pay income tax and the 10% additional penalty – with some exceptions that I’ll cover next.
Con #2: Fewer Penalty Exceptions
With an IRA, not only can you make a withdrawal for any reason, but there are exceptions to the 10% penalty that come with an IRA that you don’t get with a workplace plan.
If you make an IRA withdrawal for the following 3 reasons, you’ll have to pay income tax, but get to avoid the 10% penalty:
- Higher education costs, such as tuition, books, equipment, supplies, and room and board, for you, your spouse, your children or grandchildren.
- Down payment for a first home up to $10,000, as long as you (or your spouse) didn’t own a principal residence during the past 2 years.
- Heath insurance premiums if you’re unemployed.
Con #3: Limited Investment Choices
Having all your retirement money in a workplace plan means that you’re limited to its menu of investment choices. They might be more or less extensive than choices in your IRA.
Every retirement plan is different, so take a look at the investment options and make sure there’s plenty of variety to give you a well-diversified portfolio.
Con #4: Fees May Be Higher
With a workplace plan, you’re stuck with its fee schedule. Due to the administrative responsibilities of a 401k or 403b, they’re relatively expensive to run, and these higher account fees can erode your investment earnings over time.
On the other hand, with an IRA you have freedom to shop around for the best plan that has the lowest fees and most attractive investment options. So compare the expense ratios and fees in your IRA and 401k to evaluate whether a reverse rollover makes sense.
Con #5: Less Account Diversity
Having all your retirement money in a workplace plan means that you’re limited to its menu of investment choices. They might be more or less extensive than choices in your IRA.
If you roll over your IRA into your workplace plan, you won’t have an IRA to contribute to. But if you keep your IRA in place, you can contribute to both each year.
However, depending on your income, contributions to a traditional IRA may not be fully deductible when you’re also covered by a workplace plan.
For instance, for 2015, if you’re single with modified adjusted gross income over $61,000, you can still contribute to and even max out both a 401k and a traditional IRA in the same year, but you won’t get the full IRA tax deduction. If you’re married and file jointly, the income threshold goes up to $98,000 for when the tax deduction begins to phase out.
But even if you don’t get the full tax deduction, your traditional IRA contributions will still grow tax-deferred in the account, which is a terrific benefit. If your income isn’t too high, you could consider contributing on an after-tax basis to a Roth IRA instead.
See also: Your Guide to the Roth IRA, Part 1
Should You Do a Reverse Rollover?
I’ll sum up and answer Michael’s question about whether he should do a reverse rollover with a general recommendation: I tend to lean toward the option of keeping an IRA in place and starting with fresh contributions into a new workplace retirement plan.
Michael mentioned that his new 401k would have matching, which is really great. But you never get matching on funds that you rollover into a workplace plan, only on your new contributions.
If your IRA isn’t impressive compared to your employer’s plan, another option is roll it over into a better IRA with lower fees, more investment choices, or more convenience.
More Money Resources
The Rules for Using a Spousal IRA
Rollover Chartopens PDF file (a summary of allowable rollover transactions)
Where to Rollover your 401k Retirement Money
3 Money Mindset Tips and Tools for Surefire Financial Success
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
