Roll Over And…
Although not at all the focus of this blog, I start with a quote from a recent report from the National Institute on Retirement Security:
“Few people contribute to [IRAs] on their own… most IRAs contain rollovers from employer-sponsored 401(k)s and other DC [Defined Contribution] plans.”
The very important point of their report was that the many millions of workers who do not have a workplace retirement plan do not save for retirement at all. All of those IRAs out there? They mostly exist as depositories of funds that used to be in a 401(k) (or similar).
Which brings us to today’s topic: If you leave your employer, should you take your 401(k) with you?
No points will be awarded if you guessed the correct answer which is, of course, “It depends.” This is what it depends on:
Go Ahead! Roll that 401(k) (or TSP or 403(b)) into an IRA!
By far, the most compelling reason I have observed IRL for rolling an old workplace retirement account into an IRA at the investment firm of your choice is ease of management. Oh, the number of times I have met clients with as many retirement accounts as they have fingers (just on one hand, but still). You have little hope of being on top of your investment choices if your accounts are scattered about, all with different logins and passwords that you forgot long ago. The problem is only compounded after you retire and must manage withdrawals from your accounts.
The conventional rap on workplace retirement plans is that they are loaded up with high fee investment choices, such as actively managed funds. I believe that this is less of a problem now than it was in the past, but the issue certainly persists, especially in state and local government employer plans and the plans of small employers. Fees matter. Look at the expense ratios of the fund choices in your old plan and compare them to the lowest of the low index funds. If you don’t like what you see, this is an excellent reason to move on.
Or maybe your old employer plan has perfectly fine conventional offerings, but you are looking to move your portfolio to choices that better reflect your values. While not impossible, few workplace retirement plans offer much in the way of ESG investing. Moving to an IRA can allow you to express your values through your investment choices in a way that your old 401(k) cannot.
Finally, you may be on the cusp of retirement and have built up a pretty healthy balance. And you have concluded that you would prefer someone else to manage your account. By a country mile, the dominant fee model in the investment management industry is Assets Under Management (AUM). This means that the financial advisor will take on the responsibility of choosing investments on your behalf, as well as the ongoing tasks of managing a portfolio, such as rebalancing and perhaps regularly sending you withdrawals. Their compensation for performing these tasks is usually a fee based on a percentage (perhaps 1%) of the size of your portfolio. Here’s the rub: an advisor cannot charge an AUM fee of a portfolio that is within an employer plan. Hence, the need to roll it over to an IRA.
Ready to Roll? Well, maybe not so fast…
Again, let’s put ourselves in the headspace of someone leaving their final employer, and heading off to an early retirement. If that person is at least 55 years old, they can take withdrawals from the workplace retirement plan of their last employer without penalty. This is often referred to as the “Rule of 55.” And it only applies to workplace retirement plans, not IRAs. Had they rolled it over, the funds would be locked up until the usual age of 59 ½. [1]
Are you a federal employee? If so, your workplace retirement plan is the Thrift Savings Plan (TSP). What makes TSP so lovely is that it has just five very simple, very low cost index funds to choose from (plus various combinations of the five to form target date funds). I am on record as being a TSP fan girl.
Are you thinking that backdoor Roth contributions may be in your future? That’s a topic for a whole other blog (one day) so I will leave it at this: If you have a traditional IRA out there, you cannot (economically) make a backdoor Roth contribution. Leaving your funds in your 401(k) leaves open the possibility of implementing this possibly tax efficient strategy in the future.
There are a few other things to consider…
Perhaps you have landed at a new employer with a great 401(k) plan (low fees, sound investment choices). Why not roll your old 401(k) into your new workplace plan? That checks both the “simplification” box and gives you “Rule of 55” flexibility.
If you are rolling over, don’t forget the cardinal rule: Roll over “like to like.” If you have a Roth 401(k), it rolls into a Roth IRA. If it is a traditional 401(k), it rolls into a traditional IRA (unless you plan to engage in a conversion, i.e., paying taxes today to avoid paying taxes later).
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[1] OK, yes, there is potentially another way around the penalty: Substantially Equal Periodic Payments (SEPP), known as IRS Rule 72-t. But this is rather complicated and beyond the scope of this blog.