For the first time, DH has left a company (it went out of business) and the 401K provider won’t let him keep his IRA with them. (He still has a 403b with Fidelity at the university from when he was an assistant professor.) All of the money is in a traditional 401K, not a Roth.
When you’re in that situation, you have four options.
- Take the cash and pay a penalty
- Roll the 401K into your current employer’s plan
- Roll the 401K into an IRA
- Roll the 401K into a self-employment retirement plan
Taking the cash and paying a penalty is a bad idea for most people, unless it is a very small amount of money and you need it. If it’s a large amount of money you probably want to keep it in retirement because if you declare bankruptcy it will be protected. This is the kind of thing you’d want to do some serious research on before doing (as opposed to letting it just happen like #2 did once because it’s the default).
Unfortunately, DH’s current company hasn’t listened to DH’s friend and coworker yet who got DH’s last company to switch over to Fidelity (with DH’s help and my urging) so the fees on the plan are ridiculous. We don’t want to roll over to them. (It seems to be a very popular retirement company for start-ups– they suspect it’s super cheap for the companies and puts all the cost on the employees.)
Ideally we would roll over into an IRA. IRAs are great because you have control and you can use any firm you want, like Vanguard!
There’s another wrinkle though– since we want to be doing Backdoor Roths every year, all that IRA money needs to be Roth money, not Traditional. Unfortunately, DH’s 401k is all traditional (probably because the expensive original firm didn’t do Roths and then I was protesting Trump by switching everything from Roth to traditional). So that means that on top of the IRA rollover, we also need to move everything from traditional to Roth and pay taxes on it. If we don’t, then doing a backdoor Roth will be complicated. Basically we would end up pre-paying some amount of the taxes owed on the traditional IRA each time we did a backdoor Roth (this is called the pro rata rule). In theory, the taxes on the principal would come out the same in the end, but having to figure out what to pay each year sounds unpleasant. It could also increase our tax bracket for the year and we’d eventually be paying taxes on earnings too.
How much money are we talking about? $232,000. That is not chump change, and from what I read, that entire amount would be added to our income for the year if we did a Roth conversion, much of that in higher tax brackets than we usually face (even with DH’s unemployment this year).
So… for a while it seemed like the best option was 2, and we would just eat the additional 0.7% fee they add on to everything until DH and his friend can convince the company to move to Fidelity.
But then DH did some more digging into that option 4– and decided it was worth trying out.
DH looked into the solo 401k, because he had self-employment income as a sole proprietor this year.
There was a concern that 401k plans that do not get contributions can become dormant, and may even be considered non-qualified by the IRS. However, according to this page:
The IRS considers a sole proprietorship once established to continue until the death of the sole proprietor. Section 401 explicitly considers an individual with earned income from self-employment in any prior year, even if there is no earned income in the intervening years, a self-employed individual eligible for a 401k. Only the termination of a business entity that is the sponsor of the 401k requires the termination of the 401k plan.
This is the difficult official language about Discontinuance of Contributions:
Consider all of a case’s relevant facts and circumstances; but generally, in a profit-sharing or stock bonus plan, consider the issue of discontinuance of contributions if the plan sponsor has failed to make substantial contributions in three out of five years.
Vanguard didn’t used to accept rollovers from other plans into their Vanguard Solo 401k, but they do now. So we went with them.
So after all of this research to make sure that DH could create a Solo 401K and didn’t need to contribute to it every year and could rollover, the hardest part was being on hold with Vanguard waiting to talk to a representative.
Once DH got off hold, the representative answered his questions double checking that he could do a rollover and could open the 401K and didn’t need to make additional contributions or anything like that. DH answered some basic questions like he’s the plan administrator, that I was the beneficiary rather than whoever he happens to be married to at the time of death (thanks, DH! but let’s not get divorced), and a fund to start with (he can decide on other funds later, which he will do later once it’s made). There’s a fee per fund, but it’s waived because we have lots of money with Vanguard already. The guy said it would take a few days to get the account (technically a plan for the company and an account for DH, the sole employee) created after DH requested the account and signed some forms online and we should get an email from Vanguard when it is ready.
After the account is done, he should be able to contact his old plan, Fidelity, to tell them that he’s rolling over to this new Vanguard account. We’re hoping this will go smoothly and there will be no mailing of checks involved.
The Form 5500 will have to be filed annually once the plan is $250+k.
We will update if anything goes wrong!
DH notes that when you get the notice about plan termination, you may only get a month to figure out how you’re going to transfer and to get the transferring done, which is plenty of time if everything goes smoothly, but isn’t plenty of time if it doesn’t. So don’t sleep on it!
Have you ever rolled over a previous employer’s retirement account? What options did you pick?