I’m a big fan of rolling over 401K plans into IRA accounts. For many people, a 401K plan will represent one of their retirement income ‘prongs’ along with after-tax savings, pensions, and social security. Many workers of various ages have money in 401K plans because they’ve learned that salary reductions into 401K plans will reduce one’s taxable income and grow those funds on a tax-deferred basis until those funds are withdrawn during retirement. It’s a very widely used retirement savings vehicle. So why not just leave those funds in your 401K if you switch jobs or retire? I’ll give you my take on this below:
- Fees. Your 401K plan may have expenses in any number of places which you don’t typically think about. Those fees include administrative and servicing fees to TPA (third party administration) and don’t forget about investment management costs. Very large 401K plans (those plans with hundreds of millions of dollars) may sidestep or minimize their cost structure through scale, access to lower-cost institutional share classes, etc. But for many 401K participants, you are paying numerous fees which are likely disclosed to you but that isn’t really reducing your cost structure in any way. Rolling your 401K into an IRA gives you the opportunity to dramatically reduce your fees.
- Flexibility. How many 401K plan investment options do you have? I’m guessing somewhere between 8 and 15, maybe 20. If you have 20 that isn’t terrible… you probably have a couple of options for large, mid and small-cap along with a couple of international options and maybe a few bond investments. An IRA allows you to invest in individual stocks (if that’s something you want to do), individual bonds, and other exchange-traded products which provide broad access to the markets. In fact, you can most likely select the same investment options which you have within your 401K plan, plus many thousands of others. To me, it’s a no-brainer to opt for the IRA.
- Consolidation. Many of us work for 2 or 3 companies in our lifetime, maybe 5 or 6. Leaving 401K plans with your prior employers is an easy way to lose track of what you own and make many common investing mistakes such as redundant holdings and owning investments which aren’t properly reflecting your changing investing objectives and risk tolerance. Roll your 401K into an IRA and you can have one central account with potentially more investment options (at potentially lower costs) from which to manage your various retirement accounts.
It should be noted that 401K rollovers have become more of hot-button issue now than they have been in years past. The reason for that is likely the number of baby boomers starting to retire and deal with issues surrounding their 401k, 403b, and other retirement plans. In my opinion, most people will benefit from a rollover. However, there are a couple of not-so -common reasons why keeping your funds in a 401K plan may benefit you. Those reasons include utilizing loan provisions and taking advantage of the credit protection offered by ERISA. There may also be an opportunity to avoid RMD (Required Minimum Distribution) with your 401K plan if you are over 70.5 and still working.
For most people, however, especially those in their 40’s and 50’s who have old 401K plan sitting around that could be moved into an IRA, I think the advantages associated with lower costs and more investment options will prove very valuable, especially over long periods of time.
As always, feel free to contact me with any questions or concerns.
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“As each individual’s tax situation is different, take time to consider all the facts and consult with your tax advisor before initiating a rollover. Distributions received before age 59 1/2 are subject to an early distribution penalty of 10% additional tax unless an exception applies. This information is not intended to be a substitute for specific individualized tax, legal or estate planning advice.”