I am currently involved in a rollover of a 401(k). While I anticipate the process will go smoothly, that isn’t always the case. In my situation, I plan on setting this up so the plan sends the money directly to an IRA fund family I am already invested in (but haven’t done all that much with because of the 401(k)). This is the easiest option for all parties concerned and the most prudent for many retirement savers. But suppose you aren’t already set-up in an IRA?
Most of us have access to 401(k) plans (and I say this knowing that too many people don’t invest in one even if they have access) and some of those plans are quite good. What constitutes good? A good 401(k) plan will reflect your needs and that means the plan administrator has some clue about the workforce the plan is designed for: Too conservative (geared toward might be an older workforce) and you will find on beneficial investments if you are young) or it might be too broad (and attempt to appeal to every one and in doing so, complicates matters for those who might be looking to protect what they already have).
Good is also determined by participation. While the automatic enrollment of new hires has significantly increased how many join the plan (you have the option to opt-out), if the plan doesn’t feel worthy of additional contributions (beyond what the employer set-up), then the plan has more or less failed in its mission.
Your 401(k) should reflect who you are and offer you investments suitable to those needs. Of late, many plans have added target date funds or as they may have been previously known as lifestyle funds. These are the plan’s fund of choice when they engage in auto-enrollment, removing some of the fiduciary responsibility by simply picking a fund that suggests a future retirement date decades down the line. This doesn’t mean the fund is good and it doesn’t imply that you will need to keep the fund for over thirty years in order for it to work. The choice simply solves a legal obligation to do what they think is best.
Your 401(k) may have index funds, balanced funds (a 60% equity/40% fixed income split), actively managed funds (although these are being weeded out as the focus on fees moves more and more into the limelight) and possibly exchange traded funds (ETFs have made inroads into some plans as participants have pushed to have this broader, largely indexed and lower fee option added). But if you plan is small as many are, the options may be very limited.
In truth, the rollover may be the best option for most of us. It is for me. My plan has lower fee choices available but they seem to offset higher overall administrative costs. It is sort of a smoke and mirrors effect. And with the thousands of choices available outside these limited plans, the rollover is actually a blessing of sorts.
But do it right or the problems can multiply. First, have an IRA already in place. This basically is the most streamlined approach and incurs no costs to you. If you decide to take the distribution, then you have 60 days to get the money into a qualified plan. The process, as I mentioned is streamlined – you provide your contact info and the account and routing numbers for the brokerage account where you’ll send the money, and then select the type of distribution you’d like. In this instance, you should opt for direct rollover, which moves the money directly into your IRA.
Without an IRA currently in place, the 401(k) will distribute the money to you. No matter what your economic and financial situation is, avoid the lure of simply keeping it. Penalties (10%) and income tax (your current rate) will be applied and this might seem like a smart move if you are cash strapped. But your problem, whatever it is, is probably short-term in nature. Your retirement savings and the advantage you have had by putting the money away will never be recoverable.
There are problems that can crop up. Be sure that the money goes in an IRA brokerage account. Failure to do so could cost you those penalties and if you fight the IRS, it might cost you thousands more to fix the mistake. Be sure to keep track of the rollover, make sure it goes into an IRA and don’t let it languish once its there: use it.
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