You’ve worked hard and religiously steered a chunk of your income into your 401(k). But now you’ve left — for another job, a working hiatus or retirement. What’s the best way to handle that nest egg?
You have three options: keep the money in the old company’s 401(k), move it to a new employer’s plan, or do a rollover into an IRA.
“In most cases, I would recommend rolling over an old 401(k) into an IRA,” says Stephanie Genkin, a Brooklyn, New York-based certified financial planner who gives courses on the topic. But while many financial advisors agree, most say the decision is not a slam dunk in every case.
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Shifting to a new 401(k) or IRA is easy, requiring only a little paperwork provided by the new account administrator. Sticking with the old account is obviously even easier — so effortless that many investors do it without exploring the alternatives. A change clearly makes sense if you don’t like the investing options in the old plan. But if you’re happy with them, the considerations are numerous.
Among the most important is fees, says Terry Dunne, managing director of rollover solutions at Millennium Trust Co. in Oak Brook, Illinois. “Both the plan and IRA will have different costs for the participant,” Dunne says. “Generally, but not always, the cost to a participant in a plan is less than the costs of an IRA.”
To make it more complicated, though, fees as a percentage of the account are typically the same for all participants in a 401(k), but are discounted in IRAs for people with larger balances, Dunne says.
And don’t just assume the 401(k) fees are lower. Though it can take some extra effort to get a full accounting from an employer or 401(k) administrator, the results may be startling, says Jerry Linebaugh, founder of JLine Financial in Denham Springs, Louisiana.
“The annual fees for a 401(k) can easily be more than 3 percent, and in some cases more than 5 percent,” he says, adding that “studies show most people have no idea of the fees they are paying in their 401(k), and many assume they are paying little to no fees.”
Yes, it’s complicated. Here are a few things to consider.
How good are the old and new 401(k)s? Choosing from among the three options starts with assessing the old 401(k) as well as one offered by a new employer, if you have one. How do the investing options and fees compare? Does the old 401(k), or the new one, give you access to mutual funds that are closed to new investors — ones you couldn’t get in an IRA?
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If the new 401(k) isn’t as appealing as the old one, you can leave the old account alone or roll it into an IRA. But you might want to put new savings into the new employer’s plan anyway, in order to get the tax deduction on contributions and any matching funds the employer offers. Also, you may be permitted to borrow from the new employer’s plan, while you would not be able to borrow from the former plan after leaving that job.
Be sure to look at the big picture. If your long-term plan calls for a certain mix of assets, such as, say, 60 percent stocks and 40 percent bonds, each account need not have that mix so long as they do when taken together. So if the old 401(k) offers attractive stock funds but its bond funds are less attractive, you could do the lion’s share of your bond investing in the new 401(k) or IRA.
Value of incidentals. Look at the services each plan offers. Some employers, for instance, provide free or discounted advice from financial advisors. All else being equal, it could be worth it to favor the plan that offers planning help.
Then think about when you will want to start making withdrawals.
“An advantage of a 401(k) is that upon separation of service from a company at age 55 or older there is no penalty for withdrawal of funds,” says T. Michelle Jones, vice president and portfolio manager at Bryn Mawr Trust in Bryn Mawr, Pennsylvania. “However once funds are rolled over to an IRA, the age is increased to 59½.”
The early withdrawal penalty is 10 percent.
What options to you have in an IRA? That’s a trick question. The biggest advantage of the IRA rollover is the virtually unlimited investing options — stocks, bonds, funds, CDs, commodities, real estate, you name it. That can be pretty attractive if you’ve chafed under limited or unsuitable offerings in the old 401(k), though some plans have a brokerage option open to almost any kind of holding.
“Most plans will not allow you to invest in individual stocks at all, unless there is an option to invest in the company stock that is publicly traded,” says Martin Buchanan, founder of Buchanan Capital Management in Oklahoma City. Also, you can no longer contribute to a 401(k) after leaving the company, while you could continue putting money into an IRA, he says.
Buying and selling can be done more quickly in an IRA, which could be valuable in a rapidly changing market, he says.
[Read: How to Retire Without a 401(k).]
“Some 401(k) plans will limit how many times a plan participant can change investments” during a given period, Buchanan says. “This means that a plan participant might get stuck in an investment that they do not wish to be in because they have exceeded the maximum.”
Keep cool. Though an IRA may have more options, you may not need that many. If you are an ordinary investor preparing for retirement and don’t want to make investing into a second job, a few good index funds or target-date funds might be enough, and you may have perfectly good choices in your 401(k).
“The limited number of investment options in a 401(k) is often considered a drawback, but this limitation can protect investors as long as the available funds are diversified and low-cost” says Benjamin Sullivan, a portfolio manager with Palisades Hudson Financial Group in Austin, Texas.
“Staying in a 401(k) can prevent investors from making a costly mistake such as concentrating an IRA in couple of speculative stocks,” he says.
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How to Choose Between a 401(k) and an IRA originally appeared on usnews.com
