When I left my last place of employment, I rolled all of my 401(k) funds into a traditional IRA. I figured doing so was a no-brainer, but I recently read an article in Kiplinger’s Retirement Report that, while validating my decision, also gives some reasons why a rollover is not always the best course of action.
It seems that brokerages and employers are increasingly competing for those retirement funds. According to the Investment Company Institute, more than 50 million employees and retirees hold $3 trillion in 401(k) plans, which means that brokerage firms and mutual fund companies are clamoring for the business. TD Ameritrade and E*Trade are offering up to $500 to buy rollover business.
At the same time, employers who have been historically non-committal about keeping retirees in their plans have begun offering low-cost index and exchange-traded funds, target-date retirement funds and annuities as a carrot to hang on to 401(k) participants.
So…should you roll your 401(k) to an IRA or not?
Advantages of rolling a 401(k) to an IRA
More investment choices
The very best 401(k) plans have limited investment options whereas an IRA gives you access to nearly unlimited investment options.
With an IRA, you can withdraw money whenever you need it, but not necessarily with a typical 401(k). Some limit the frequency of withdrawals; others set all or nothing restrictions.
Many workers leave a string of 401(k) investments behind as they switch jobs over their career. Rolling all into a single IRA greatly simplifies the retirement savings; making it easier to monitor investments, plan allocations and rebalance.
Easier to handle required minimum distributions (RMDs) at age 70 ½
With traditional IRAs (there is no RMD for Roth IRAs), the RMD is based on the total amount in all your IRAs with the RMD distribution coming from any account or combination of accounts. With 401(k)s at age 70 ½, you must calculate each RMD separately and take the money from that account.
Some estate planning advantages
Heirs can normally take tax-deferred distributions from an IRA over their lifetimes; most 401(k) plans force heirs to take assets after the account holder dies. Note that the beneficiary has the option of rolling the 401(k) into an IRA, but this is a tricky process and is better done by the account holder while living.
Reasons for sticking with your 401(k)
Relaxed penalty rules for early distribution
If you retire or get laid off between ages 55 and 59 ½, you are able to take penalty free distributions from a 401(k) while you would be penalized 10% for withdrawing funds from an IRA.
Protection from creditors
The 401(k) funds can’t be touched by creditors in a bankruptcy or by plaintiffs in a civil lawsuit. IRA funds, however, have limited protection and differ from state to state.
Delayed RMD for workers over 70½
As long as you are still working at age 70½ , no required minimum distribution is taken from your 401(k). With an IRA, the RMD is a must whether you continue to work or not.
Possibility of rolling an inherited plan to a Roth IRA
New rules allow nonspouse beneficiaries to roll a 401(k) to a Roth IRA, something that cannot be done with an inherited traditional IRA.
Some retirees are used to their 401(k) plans and are not comfortable with starting out fresh with the management of an IRA.
How about the costs?
Deciphering the management expense of your 401(k) or IRA can be a challenge. With your 401(k), you will need to find the expense ratio of each fund. How do you do this? Try the fund’s Web site or the plan’s Web site. According to Kiplinger’s Retirement Report, an expense ratio of 1% or less is reasonable. You shouldn’t have trouble finding funds in your IRA with comparable expense ratios. A new tool, by BrightScope, a San Diego firm, has tabulated the administration costs, investment fees, returns and quality of investments for 45,000 companies. Visit www.brightscope.com, enter the company name, and you will get a score of between 1 (worst) and 100 (best). Give this tool a try…it is really that simple.
Because of more choices, flexibility and simplicity of the IRA, most 401(k) holders should seriously consider rolling to the IRA. However, this decision is not a no-brainer. Think it through and understand what you are doing before deciding.
When leaving employment with a 401(k) provider, have you rolled your 401(k) to an IRA, rolled it to your new company’s plan, left it in your previous company’s plan, or cashed it out? Why did you make the decision you made? What recommendations would you give to others who are leaving a 401(k) employer?