Stern Advice - The benefits of depositing your IRA into your 401(k)

NEW YORK, April 9 Wed Apr 9, 2014 11:48am EDT

NEW YORK, April 9 (Reuters) - It may sound like something you would train your dog to do, but the "reverse rollover" is a maneuver that more retirement-minded workers should try.

The move - taking personal individual retirement account (IRA) assets and moving them into your company 401(k) plan - sounds counterintuitive. Why would you do that once you have wrested your money from a former employer and rolled it over into your very own personally controlled account?

It turns out there are a few reasons. For starters, 401(k) plans offer some benefits that individual IRAs do not.

You can access your money penalty-free at a younger age if you retire early. The funds in your 401(k) have greater protection against legal judgments. And you may find the 401(k) offers a better investment package at lower costs than you can find on your own.

Currently, 69 percent of company 401(k) plans allow workers to bring IRA money to them, according to the Plan Sponsor Council of America, an employer group. Workers can only move IRA money that was seeded with pre-tax dollars, either via a rollover from an earlier 401(k) or from contributions that were originally tax-deductible when they were made to the IRA.

The strategy does not seem to be well-publicized, and it is not clear whether many workers take advantage of it.

Now there are a couple of new reasons why reverse rollovers may become more popular. Last week the U.S. Treasury Department and the Internal Revenue Service issued guidance making it easier for companies to accept reverse rollovers without having to worry about being held liable if workers put money into a 401(k) that should not be there. So more employers may start allowing these deposits.

Furthermore, a reverse rollover can help high earners maximize their after-tax retirement savings and income because of the way it works with the latest rules governing Roth IRAs.

Here are some pros and cons, and pointers on how to decide whether the reverse rollover is a trick you want to do.

POSSIBLE BARGAINS

You may get better investments, cheaper. If you work for a large company, there is a good chance that it has put some effort into making sure you have state-of-the-art investment choices. You probably have separately managed accounts within your 401(k). They are portfolios of investments created for your plan that cost less than mutual funds.

Even in mid-sized plans, you should have carefully curated low-cost mutual funds. The plan may even offer free advice on how to split up and invest your money.

If that is the case, compare it with what you are doing on your own. If you are paying more than 1 percent of your assets in advisory fees and then also paying 1 percent or more in mutual fund fees, that is an argument for rolling over into the 401(k). If, instead, you are already holding your IRA in low-cost funds and individual stocks and bonds, you may not want to go to the 401(k).

EARLIER WITHDRAWALS

You typically cannot take money out of an IRA penalty-free until you are 59-1/2. But you can take withdrawals from a 401(k) once you are 55 and have separated from your employer.

Planning an early exit? Move money to the 401(k) so you can get to it earlier.

LESS CONTROL

If you want to pull your money out (albeit with penalties and not usually a good decision), you have more leeway to do that with an IRA than with a 401(k) plan, although the latter allows hardship withdrawals. The investment menu in the 401(k) is much smaller than the great big world of Wall Street that you can buy through any brokerage IRA. These are IRA expert Ed Slott's main objections to the reverse rollover.

ROTH STRATEGY

High earners can use this tactic, which is complex, so bear with me.

Roth IRAs are prized, because all of the money they earn is tax-free forever if it is used in retirement, once the initial contributions are made with after-tax money. But there are income limits on who can contribute to a Roth. If you make more than $129,000 as a single person or $191,000 as a couple filing a joint tax return, you cannot contribute to a Roth.

The back way around that is to contribute every year to a traditional tax-deferred IRA and then convert that IRA to a Roth, paying taxes on the converted amount that has not yet been taxed. The maximum contribution for any type of IRA is $5,500 (plus an extra $1,000 if you are over 50).

But there is a problem with that too: If you have older IRAs, you have to pro-rate the amount you convert among all of your IRA money and not just pull from your latest contribution. That could result in a sizeable tax bill, as the older IRA money has probably accumulated untaxed earnings that will have to be taxed as they are moved to the Roth.

Here is where the reverse rollover helps: You can move all of your old IRA money into your 401(k). From then on, do the contribute-to-traditional-IRA-and-convert-to-Roth move. In that way, there will not be any old tax-deferred IRA money to which you will have to allocate a portion of your Roth conversion.

"From a tax standpoint, it's a very nice opportunity," says Bill McClain, an actuary and retirement plan specialist at consulting firm Mercer.

Bottom line? If you are a high-earning couple over 50 and you both do this, it will enable you to put $13,000 a year into Roth accounts while paying little, if any, extra tax.

And that, says McClain, may entice more senior employees to ask their employers for those reverse rollover opportunities. (Editing by Lisa Von Ahn)

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