Should I roll over my 401(k)?
Q. - Should I roll over my 401(k)?
A. - A recent CNBC article posing this question was titled: “401(k) rollovers can be costly and irreversible. What to know before moving money.” Because I favor rollovers over staying in 401(k)s, I wondered if I was missing something. So I read on.
First, before discussing the article, let’s review the issue. When you are employed and your employer offers a 401(k) plan, both your contributions and your employer’s must be invested in the plan through the financial services provider the employer has chosen. This provider offers a limited number of funds (about 20) that together meet the provider’s fiduciary responsibilities to offer investments appropriate for retirement savings. You will be limited to these offerings as long as you are employed with that employer or as long as you leave your money in the plan. Your choice when separating from service (leaving the company, being laid off, or retiring) is: (a) to stay in the plan, (b) to roll over to an IRA, or, if still working, (c) to move the assets to your new employer’s plan. You are not forced to roll over; the money stays in the 401(k) as long as you leave it there (though small accounts are usually cashed out when you leave the company).
As I said, I was intrigued by the article stating that rollovers can be costly and irreversible. The article correctly noted that you can only do a rollover after you separate from service and that you can’t reverse the decision. However, the article failed to mention that you can always move the rollover to another financial service provider at any time later if you want to.
Then the article’s author tried to make the case that you may incur lower fees because the 401(k) allows investing in “institutional class” fund shares, which have lower expense ratios. And while that might be true, there is no obligation to offer that class of lower-fee shares, or to have all of the 401(k) funds offered in that class of shares (my experience is that is not the case). The article cited a study showing how much the fee difference (1% vs. 0.25%) would add up over a 25-year retirement, ignoring that today most large financial providers for rollover IRAs offer many retirement and index funds with expense ratios under 0.5%.
The article also ignores the fact that retirees switch to more conservative investments and draw down their balances, minimizing the savings one would get from institutional-class shares after retirement. It also ignores the fact that retirement income funds are not common in 401(k)s. Yes, expense ratios are important, and lower is better. But striving to save another 0.2% by staying in the 401(k) won’t matter over a 25-year retirement, since the fund offerings available and your needs are bound to change.
The biggest miss in the article, in my opinion, is that 401(k) plans are designed for employees’ working years, not their retirement years. Frankly, why would your employer care much about your retirement finances once you’re off the payroll? That’s why a rollover IRA at a major financial services provider that offers 100+ “low expense” funds is the better choice in my opinion. Finally, here are four additional caveats to note.
(1) You cannot take penalty-free withdrawals from a 401(k) or Rollover IRA before age 59 ½ unless you meet certain conditions. One condition for a 401(k) is that withdrawals can be penalty-free if you separate from service in or after the year you turn 55 and take them from your last employer’s account. If you instead roll over that 401(k) and take withdrawals, you would then face the 10% penalty. This consideration only matters if you are planning to retire between the year you turn 55 and 59 ½, when 401(k) withdrawals are penalty-free from your last employer’s account.
(2) If you use a financial advisor, they may want all of your assets in a rollover IRA because that allows them to count them as Assets Under Management (AUM) and charge higher fees. If the assets remain in a 401(k), they won’t “manage” them. They’ll just advise you on what to do with your available 401(k) funds, but you’ll have to perform the transactions.
(3) 401(k)s can offer more protection from creditors than IRAs if you file for bankruptcy. This is because they are covered by the Employee Retirement Income Security Act (ERISA), whereas IRAs are not. That said, rollover and Roth IRAs are currently protected up to $1,711,975 in total per person.
(4) A 401(k) plan may not allow regular monthly distributions or distributions from specific funds, whereas a Rollover IRA will support more robust automated transactions. The 401(k) website will likely be more limited than the financial services provider’s brokerage or mutual fund website.
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