If you’ve left a job recently, that’s one of the big questions you have to answer.
Luckily, with very few exceptions, the answer is easy: Yes, rollover your 401k as soon as possible.
Better Investment Options in an IRA
There’s no question that reducing your investment costs is one of the most reliable ways to improve your investment returns. Unfortunately, 401k plans tend to have only one low-cost investment option: an S&P 500 index fund. (And some plans don’t even have that much!) This forces you to either:
- Use subpar (i.e., high-cost) mutual funds for the remaining portions of your portfolio (bonds, international stocks, small cap stocks, etc.), or
- Overweight the S&P index fund in order to keep costs down (thereby throwing your asset allocation out of whack).
With an IRA, you’ll have access to a wide array of low-cost investment options in every asset class.
Better Access with an IRA
Over the years, I’ve had several people contact me about how to find “lost” 401k accounts. (This happens when an investor moves after changing jobs and does not inform the 401k administrator as to his new address. Meanwhile, the investor’s previous employer changes plan administrators, thereby making it so that neither party knows how to get in touch with the other.)
By rolling your 401k into an IRA, you’ll avoid any such hassle.
Lower Fees in an IRA
In addition to limiting you to high-cost funds, most 401k plans include an administrative fee. A 2009 study by Deloitte and the Investment Company Institute found the median admin fee to be 0.72% of assets annually.
In contrast, many brokerage firms charge no annual IRA fees at all. (And the rest tend to be quite modest–usually around $30/year.)
It’s likely that you can reduce your total investment costs by 1% per year simply by moving your money from a 401k to an IRA. Improving your investment return by 1% per year has a dramatic effect over a few decades.
Choosing an IRA
Of course, it’s important to find a brokerage firm that has low costs and that will give you access to the investments you plan to use. A few of the more popular low-cost places to open an IRA include:
Scottrade: No annual IRA fee. Access to low-cost investments via ETFs. $7/trade. $500 account minimum. (My review of Scottrade.)
TradeKing: No annual IRA fee. Access to low-cost investments via ETFs. $4.95/trade. No account minimum. (This is who I use. You can see my review of TradeKing here.)
Vanguard: No annual IRA fee. Access to tons of no-load, low-cost index funds. Most of the funds have a $3,000 minimum.
Zecco: $30 annual IRA fee. Access to low-cost investments via ETFs. $4.50/trade. No account minimum. (And if you have $25,000 or more in your account, you get 10 free trades per month.)
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{ 13 comments… read them below or add one }
It seems as though this is aimed at the do-it-yourselfers. What is your take on rollovers with advisers? What role do you see an adviser playing in this financial move? If at all?
Great question.
My view is that advisors can perform a number of helpful tasks: Determining an appropriate asset allocation, helping to estimate income needs in retirement, etc. Such services are valuable, and if an investor feels he/she needs such help, then it makes sense to pay for it.
On the other hand, far too many advisors pitch their services based on the idea that they offer some way to reliably earn above-market returns.
People about to rollover a 401k are in a particularly vulnerable position in that they’re marketed to very aggressively by brokers who will simply charge them a commission to invest in high-cost funds.
Just wanted to add one thing. Make sure that you do a direct rollover to avoid any tax withholdings. Completed my rollover to Vanguard two weeks ago. Pretty smooth process. Completed in just five business days.
Good post. I agree with you that the answer is pretty easy. One of times you might want to leave it in the 401k is with the ‘age 55 exception’ so you can avoid getting whacked with the 10% penalty on your distributions if you retire early.
I just talked about that rule today in my post on Retirement Milestone ages that could cost you money if you’re unaware. http://bit.ly/XBHuZ
One more reason to rollover to IRA is that traditional IRA can be converted to Roth IRA eventually. Roth IRA is even more advantageous than traditional IRA, especially for higher-income family. I wrote an article “Roth conversion: the greatest tax break you don’t know you have” just a few days ago.
http://investment-fiduciary.com/2009/09/02/roth-conversion-the-greatest-tax-break-you-dont-know-you-have/
Michael Zhuang
I just want to clarify. The “Age 55 Exception” referenced by Jason falls under rule 72t. It allows a lump sum distribution from your 401k without the 10% early withdrawal penalty when a seperation of service occurs at age 55 or later. That’s it, only lump sum and only with a seperation of service.
However, also under rule 72t is the periodic and equal distributions can be taken from an IRA account at age 55 or later without the 10% early withdrawal penalty. The IRS has a formula for the calculation of this distribution method. This cannot be done from a 401k.
Mike,
If you can comment on my article about Roth conversion, I would greatly appreciate that.
Michael
@Evolution of Wealth
I’ll have to respectfully disagree with you.
The lump sum distribution could be a requirement found in the Summary Plan Discription from your employer – they might put their own restrictions on it, but the IRS does not.
This is from Publication 17 on the IRS website:
Additional exceptions for qualified retirement plans. The tax does not apply to distributions that are:
From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees), ”
It puts no stipulation whatsoever on how the money is withdrawn. You can take as much, as little or even periodic withdrawals from an IRS standpoint.
Also, Ed Slott – known as the IRA Guru – says this at his website http://irahelp.com in response to a question about someone stopping their payments from their 401k.
“they can be stopped anytime as far as the IRS is concerned. There are no tax code rules. However, the plan might have some stipulation that the monthly withdrawals must be taken for a certain time after you start them. That would be a plan requirement and have nothing to do with any IRS requirement.”
Basically, you’ll want to check with your employer to make sure they allow this, but most of the time they do. The IRS doesn’t care how you take it.
I stand corrected.
So then the benefits of the 401k are that you would have more flexibility of withdrawals if and only if you seperated service after age 55.
Otherwise, the only penalty free access before age 591/2 is through IRA rule 72t distributions using one of IRS calculation methods. That once started need to be continued to age 59 1/2.
Fair enough?
I retired at 65 and left. employment. With the economy I lost 40,000 in my 401K but have regained 20,000 b ack. My ex-employed wants me to withdraw or rollover the 401K since I no longer work there. I would like to keep it there until I recoop the other 20,000 as I will loose money in fees, etc. reinvesting it. The reason they want me to withdraw it is that if they reach a certain number of people in the plan they will have to pay a $7,000 fee of some type. Can they force me to roll it over. I do not think it is in the plan as other people have left theirs there for years.
Hi Ruth.
As to your specific question, I don’t know the answer as to whether or not they can make you roll it over. I’d suggest asking at the Boglehead forum.
I’m not sure I understand your reasoning though. If you were to roll it into an IRA, as long as you chose no-load funds, you wouldn’t be paying any commissions to do so. Or, if you created an ETF portfolio at a discount brokerage firm, the commissions you’d be paying would be minimal (probably a grand total of less than $50).
In contrast, if you leave it in the 401(k), you’ll probably be paying an administrative fee that more than negates the fees that would be involved in an IRA (assuming you don’t take it to a broker who would attempt to sell you some expensive funds). In addition, it’s likely that the costs for the funds in your 401(k) far exceed the costs of funds you could choose in an IRA. (Though I can’t say for sure without knowing the specifics of the options in your 401(k)).
Either way, I’d suggest asking at the Boglehead forum to get some more opinions on the matter.
@Ruth – If your account is over $5000 an employer cannot force you out of the 401k plan. Between $1000 and $5000 they can do a force rollover to an IRA and with less than $1000 they can send you a check after proper notice.
Mike brings up some good points on whether to roll it over or not. One more thing to add is if you passed away and wanted the money to be passed on properly it is more advantagous to pass it on in an IRA.
Good clarification Evolution of Wealth! If it’s over $5,000 they can strongly encourage you, but not force.
By the way, “whoever has the money is the boss” as I like to say. So usually it’s better to get the $ out of the employer’s plan and into your own Individual Retirement Account.
The employer can change funds and companies pretty much at any time leaving you with not much control. Your own IRA allows you to control your own investments.