There a quite a few things to consider before rolling over your 401(k). First of which is the concept of the rollover in the first place.
The scenario is always the same: You have left an employer for whatever reason. You have invested money in the former’s defined contribution plan. For the vast majority of us who have these plans and use them, you understand the process. Contribute pre-tax dollars to a tax deferred account and withdraw upon retirement.
Most of us are acutely aware that these accounts are not without risk and loss. That reality may be a recent and unexpected education in the nuances of your 401(k) and you may have found your knowledge about the plan available to you was not as good as it should have been.
Now, you find yourself with a new job and new 401(k) plan. You might be uncomfortable leaving that money with your old employer for whatever the reason. But making this important choice will take a little bit of thought on your part.
If you decide to leave the money with the former employer, you must first determine whether they will let you. Some plans do not want your money under their management. Others may feel a fiduciary responsibility to other shareholder/investors in their plan and hold the money until the sale of your shares does not impact the others. This would be in the small print of the 401k agreement that you didn’t read – in part because you didn’t feel as though you had to.
Not to worry. If your plan administrator puts a hold on those funds, this is probably in your best interest. Selling at the bottom is never a good idea and if portions of the plan has taken a serious hit (perhaps they invested in REITs – real estate investment trusts – and want the market to recover before disbursing any money to you). Leave them there and monitor the plans recovery.
Even if you are allowed to rollover those funds, where do you put them? First thing would be to examine the old plan against the new plan. (I’ll address the 401k to IRA in moment.) There is a very good tool to help with this process, one that was designed to help plan administrators improve their own plan’s execution. But you can use Brightscope’s tool to evaluate the worthiness of the move. (You can read the article here about this 401k tool.)
Keeping the money in a 401k has its advantages. For older workers, the ability to begin disbursement at age 55 is an attractive plus. Although it is generally ill-advised under almost every circumstance, keeping the money in the 401k retains your ability to borrow from the plan. Some of us will consider keeping this option open. It’s an option albeit, not a good one.
Generally, the fees are better in a 401k. Institutions may get a much better deal from the plan sponsor and consideration of this is important in the rollover decision. A much larger plan may come with more options or simply less expensive ones. Fees are an important aspect of total return and a worthwhile item to focus on when making any decision to move.
But you may not have an option if the balance is less than $5,000. This means you are faced with the choice of taking the cash in the account (along with the 20% the account must hold for income taxes and the 10% penalty). The scariest statistic, two-thirds of you take the money and pay those hefty penalties.
Rolling your 401k into an IRA is another matter. This is for the investor who has some concept of what lies before them. If I were to guess, this type of investor has had an active roll in how their former employer’s 401k was allocated. They paid close attention to diversity, perhaps even following conventional wisdom of limiting risk as they aged.
For this retirement investor, the IRA rollover is viable option. It allows closer control of how this money is invested with a variety of considerations weighed with each decision. Not only will this investor spread their allocation over a number of funds, they will do so with an eye on fees and expenses, a consideration of performance of the fund under both good and adverse conditions, and clearheaded understanding of the risks involved.
IRAs cannot be borrowed against and restrict a penalty-free withdrawal of money before 59 1/2 years old. But the choices are the primary attraction. This investor knows, and you should as well, the risks of building a successful IRA portfolio also increase. The biggest concern is investments that crossover.
What 401k plans are supposed to do is provide the investor with a fiduciary responsibility to provide the right tools for their employees. You, as an IRA investor are on your own.
You must monitor the funds you invested in for a change in investment strategy, style drift (when a fund manager invests on the edges of what s/he was hired to do; such as when they invest in large-caps when mid-caps are the focus), and an increase in turnover (a cost for trading repeatedly that the shareholder pays for directly, often done in an attempt to boost returns in the short-term, like at the quarter’s end). You bear the burden of this responsibility to your future.
The terms of disbursement are spelled out when you leave the job in the 402(f) notice. This explains your options for handling a 401k disbursement. Even if you want to stay, your old employer really doesn’t want the continued burden.
Bottom Line: Once you receive that 402(f), begin to research your options. And even if you think that money will come in handy, never take the cash.
Paul Petillo is the Managing Editor of Target2025.com
