Rolling a 401k into a 457b

Hello, welcome to Finance Speaks. Today is a little twist.  Normally I present a topic based on an idea that we thought might be of interest, however, we received this question and thought it would be helpful to post a clip because I know many might have this same question or interest in the answer:

This is a long question but I want to read it as I received it.

If an employee has a previous 401K with another employer and they have since terminated their employment; now they are working with a governmental entity want to roll their 401K to their new 457B, is this allowed and should they roll it over?   If so can you explain the implications of those choices and what would you suggest the best route for them.

Wow! That’s a mouthful.  There are two questions in the 1 question  but before I get to the answer of this question, let me clarify that there are two different Employer Sponsored plans being discussed, however, the rules are universal.  Let’s first look at the plan design types.

The first plan discussed in this questions is a 401k Deferred Compensation Plan.  401k’s are traditionally designed for corporation.  Their distribution rules are similar to 403b Deferred Compensation Plans’ which are for non-profits and public school systems.  Lastly and also identified in this question are 457b Deferred Compensation Plans which are traditionally for governmental entities.

First, I wanted to identify the various plan types that are mentioned in this question first for those who may not be familiar with the terminology.  Now that I have covered the terminology, here is the answer I sent back to the individual:

To answer the first part of the question, yes, money from a 401k can be rolled over into the 457b plan.  However, the 401k money contributed and all of the earning from that money will be segregated via the 457b plan’s record keeping system.  The reason that it is kept separate is because 401k money has different rules than 457b money.  In order for the 401k money without IRS penalty is reaching age 59 ½ and still employed or age 55 and separated from service.  This is unlike 457b distributions that can be taken once the employee has separated from service.  I mention this because if the employee under the age of 55 is thinking 10 years from now that he or she will be taking the entire account balance out might want to remember that the total balance on the account statement is not what is completely accessible without the IRS 10% penalty.  With all of this going on behind the scenes, the employee only sees the combined amount on their account statement.

This is no way should be a deterrent, just let them be aware that the rules that apply to the money they roll over.  This object is to avoid paying penalties, so the key is understanding that the rules differ for various plan types.

Just an aside, a great rule of thumb to think about if money can be rolled between plans is “what is the first number in the plan?”  If it starts with the number “4”, the majority of the time the IRS allows the account type to be rolled over without penalty or a “tax trigger”.***

That cover an overview regarding the first part of the question.  As for the second part or more over “best route”, I prefer rolling into an IRA because there are more investment options and flexibility than an employer sponsored plan.  However, fees can be relative dependent on the investment type.  Therefore, I generally encourage movement to an IRA only after researching the various alternative.  The reason is that cheaper is not always better and there is no such thing as a “one size fits all investment”.

Now, the one key downside is that the age 55 and separated from service distribution option goes away if put in an IRA, however, there are planning methods to get around that hurdle.  I would be more than happy to meet with you to discuss this and your situation individually.

This was the end of my reply but anyone is ever looking at rolling money out of an employer sponsored plan, they should explore some additional considerations:

• What is the underlying cost of the current plan vs. the proposed plan?

• What are the restriction for distribution: ie. IRS and/or new proposed plan provider? age 55 and 59½

• Is the employer (current or new) or IRA provider absorbing some or all of the plan cost?

• Required minimum distributions (RMDs) may not be required if you
  leave assets in an employer sponsored plan if you continue to work past age 70½ (I didn’t mention this in my response because I knew the client and his occupation and we have had conversations previously about life expectancy, in his case, working past 70 ½ was not an option)

• Dependent on state and federal laws, additional creditor protections may be available if remains in an employer sponsored plan

• Are you allowed access to a large pool of investments choices?

• Are you able to make investment changes at your discretion and immediately?

• What type of distribution options are available under current plan vs. proposed plan?

• What is your level of control over the assets and investments?

• What is your risk tolerance, investment experience, and time horizon?

I hope this answers your questions!