An average American will change more than 10 jobs over his or her lifetime. In addition to learning new responsibilities and getting to know a new set of colleagues, job change brings about the big question: what should you do with your old 401k? Leaving a trail of legacy 401k accounts behind as you move from job to job is not optimal, so many professionals get talked into rolling their old 401k accounts into Individual Retirement Accounts or IRAs.
Let’s make one thing clear: rolling a 401k into an IRA is virtually always better than cashing it out. A cash out decision can compromise the long term growth potential of your retirement savings, and rake up penalties come tax time. However, the rollover into an IRA is not always the best idea either – at least not until you have investigated further. IRAs are usually “sold” as the better option because they offer more investment choices, an ability to consolidate accounts, and greater control. Let’s take a look under the hood, so that you can be well-informed!
Fees, fees, fees.
Sure, you may be getting more choices with an IRA – but they come at a cost. Large 401k plans usually have access to inexpensive funds, so your fees and expenses can go up dramatically if you move into an IRA. The fees may look small enough individually, but they do add up! To make those percentages and basis points more tangible, consider calculating the total monthly fee in dollars. A side-by-side comparison of the total expense for your 401k versus IRA is the best way to do your due diligence.
Investment options and control.
I like to use a supermarket analogy here. Imagine yourself standing in the cereal aisle with 40 different kinds of cereal. Cheerios, CocoPuffs, and Froot Loops clamor for your attention, along with organic strawberry granola and muesli. The huge number of options may matter if you actually want to buy a certain cereal, but it is completely irrelevant if you would rather have eggs for breakfast. Study the investment options offered within the IRA, and make sure they matter to you – before you make the jump.
The same goes for the claim that an IRA will give you more control over your investments. Some people want to be self-directed in managing their retirement savings, but most will just stick with the recommendation of their financial advisor. Theoretical control does you no good if you won’t actually use it.
Ability to consolidate.
Keeping track of multiple 401k accounts is cumbersome: monitoring fees, risk exposure, and investment choices is difficult enough within one portfolio! An IRA might look like an attractive spot to park all of your old 401k’s, but keep in mind that it may not be your only choice. Some employers do give you the option of consolidating your old 401k plan into theirs.
So, when is a rollover into an IRA a good idea?
If you cannot move your old 401k plan into a new one because the new plan does not accept transfers or does not exist, investigating an IRA rollover is a good next step, provided that the fee structure is right. Keep in mind that expenses won’t be the only thing that changes with the roll-over.
- Unlike a 401k, you won’t be able to borrow against your IRA balance for more than 60 days without incurring taxes and penalties.
- You won’t be able to tap the IRA until you reach 59 ½ without a penalty (compare that with a 401k, which you can access once you are 55 and have left your job).
- Your entire 401k balance is protected against creditor claims in bankruptcy court; you IRA balance is only protected up to a specific maximum balance depending on your state of residence.
The bottom line is that an IRA rollover may or may not be the right choice for you, depending on your financial circumstances, options available to you, and the fee structure of the account. Don’t get sold too quickly, and be sure to speak with a trusted financial planner to make the long-term decision!
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