Most of us are familiar with the concept of doing a rollover from a workplace retirement plan, like a 401(k), to an IRA account at an outside custodian. This is a common practice when leaving a job and allows investors to have a more direct approach to managing these retirement assets in that an IRA will generally offer a wider array of investment choices compared with a 401(k) plan.
In some cases, a reverse rollover from a traditional IRA to a traditional 401(k) account can make sense.
What is a reverse rollover?
A reverse rollover is essentially the reverse of rolling over a 401(k) account from a former employer to an IRA. A reverse rollover entails rolling money in a traditional IRA to a traditional 401(k) at your current employer. Note that only money contributed on a pretax basis can be rolled out of the IRA and into a 401(k). Additionally, not all 401(k) plan sponsors will accept a reverse rollover so it is important to check with your current employer to be sure they will accept a reverse rollover.
Some reasons you may want to consider a reverse rollover:
Delaying required minimum distributions
If you are still working at the age when you must commence RMDs, you may be able to delay taking RMDs on money held in their 401(k) plan. This exemption will only apply to money in this 401(k), RMDs must still be taken from any other IRAs, old 401(k)s or other accounts where an RMD is required.
In order for you to be able to delay RMDs on the money in your employer’s 401(k), the employer must have made the proper election to their plan to allow for the ‘still working exemption.”
Once you leave the employer, you will need to include the amount from their plan in the amount used to calculate your RMD each year going forward.
Backdoor Roth IRA and the pro rata rule
Rolling pretax money over from a traditional IRA to your employer’s 401(k) can help reduce or eliminate the impact of the pro rata rule on backdoor Roth IRA conversions. Under the pro rata rule, a backdoor Roth IRA conversion made with an after-tax contribution to a traditional IRA will be taxed based on the ratio of money contributed on a pretax basis plus earnings to money contributed on an after-tax basis across all traditional IRA accounts.
By using a reverse rollover to remove these funds from your traditional IRA, you can eliminate or reduce taxes on future backdoor Roth conversions. For someone who is using this method to fund a Roth IRA due their income being too high to contribute directly to a Roth IRA, The tax savings can be significant over time.
In many states, a 401(k) will provide a stronger level of creditor protection than an IRA. By doing a reverse rollover to your current employer’s plan these assets will receive the additional level of creditor protection offered by your employer’s 401(k) plan.
While a reverse rollover can be beneficial in some cases, there are some things you may want to consider before deciding whether to go that route.
Why a reverse rollover may not be right for you:
Limited investment choices
A consideration in deciding whether or not a reverse rollover makes sense surrounds the investment choices in your employer’s 401(k) plan. The investment choices in any 401(k) will be much more limited than in an IRA. If those investment choices are of good quality and carry low expenses, a reverse rollover can still make sense.
However, if the investment menu is expensive and the investment choices are not especially good, this combination along with the limited number of investment choices might argue against doing a reverse rollover.
In doing the reverse rollover you may be giving up access to low cost ETFs and other high quality investments that might be readily available in your IRA. You will need to weigh the benefits of delaying RMDs or reducing the impact of the pro rata rule on Roth conversions against an inferior investment lineup if this is the situation with your employer’s plan.
Money in an IRA can be accessed at any time. While the withdrawal might be subject to taxes and/or an early-withdrawal penalty it can still be accessed if needed. There are some circumstances where the penalties for those under age 59-½ will not apply as well.
Once the money is rolled over to the 401(k), access will be more limited. Many plans don’t allow in-service withdrawals. You may have to wait until you separate from service with the company in order to access your money. Hardship withdrawals may be permitted as is a withdrawal in the event of a disability or financial hardship.
A plan loan may also be available if the plan permits loans. Plan loans must be paid back and can become a taxable distribution, that may also be subject to a penalty, if they remain unpaid after you leave the employer.
A reverse rollover from a traditional IRA to a traditional 401(k) account at your current employer can be a viable option for those who want to eliminate or mitigate the impact of the pro rata rule on backdoor Roth conversions, those who are looking to delay RMDs on the money while still working or those who need the creditor protection a 401(k) can offer.
As with any financial decision, you will need to weigh the potential benefits against any possible downsides.