Should You Roll Over Your 401(k) to an IRA?
Time to grab your wallet. Wall Street wants your 401(k).
The boomer retirement wave makes rollovers from 401(k) plans to Individual Retirement Accounts (IRAs) one of the biggest market opportunities for financial services firms. Nine of 10 new IRA accounts are rollovers and the President's Council of Economic Advisers estimates that $300 billion gets rolled over annually. Another potential windfall could come from lump-sum pension distributions, which also can be rolled over into IRAs.
Is it a good idea to roll over your 401(k) from a former employer or to plan to roll over the one you’re in when you leave? That depends on the quality — and size — of it.
(MORE: 7 Fatal Flaws in 401k Plans)
When a Rollover May Make Sense
A rollover can make sense if you’re in a 401(k) with bad investment choices or high fees, which can eat up a substantial chunk of your returns over time. But keeping your money in the 401(k) rather than rolling it over to a financial firm’s IRA often is the best plan.
What is the red-flag point on fees? That depends on the size of your plan, according to Brooks Herman, head of data and research at Brightscope, which analyzes 401(k) plans. Brightscope has found that big 401(k) plans (ones with over $100 million in assets) almost always have total fees below one percent; the biggest usually are below 0.50 percent. Average fees at small plans range from 1.5 percent to 2 percent, but many small plans pay more than 2 percent a year in fees.”
“If you are paying one percent in a big plan that’s high. But one percent in a small plan isn’t that bad,” says Herman. “If you’re paying two percent or more, that’s a red flag no matter the plan size.”
(MORE: Avoid Getting Fleeced By IRA Rollovers)
What IRAs Don't Have to Do
Another reason not to roll over your 401(k): this type of retirement plan is subject to the fiduciary requirements of the Employee Retirement Income Security Act, so it must put the interests of account holders first. Not so with IRAs.
“If you’re in a low-cost plan, you will pay less and have more protection,” says Herman. “A well-run 401(k) will have investment options that meet the fiduciary rule — in an IRA, you’re more in the Wild West.”
That description also can be applied to the call centers of IRA providers. They’re under no obligation to do side-by-side comparisons of the fees you’re now paying in your 401(k) compared with what you’d pay in a shiny new IRA.
And you’re likely to hear from IRA call-center reps pitches about their bigger range of investment choices. That can be a come-on to get you into higher-cost actively-managed mutual funds or to trade stocks, racking up brokerage commissions for their firms. Most investors will do far better over time with a simple menu of low-cost passive mutual funds.
(MORE: The Retirement Saver's Worst Mistake)
Then there are the cash come-ons. You may be able to get $50 to $2,500 for rolling over a 401(k) into an IRA. Everyone likes free money, of course, but if you pick fee-heavy or poor-performing funds, the bonuses will evaporate quickly.
Roth IRA Conversions and Forced Transfers
When does it make sense to roll over your 401(k) into an IRA?
Aside from doing so to avoid high fees in a 401(k), converting funds to a Roth IRA can be a good reason, too. Roth contributions and earnings generally aren't taxed on withdrawal and aren't subject to Required Minimum Distributions during your lifetime.
And if you have a small 401(k) balance, your plan sponsor may require you to roll over the money — typically that happens if your account is $5,000 or less. But a mandated rollover can lead to problems. A recent report by the U.S. Government Accountability Office found that “forced transfers” (where employers automatically move your money to an IRA if you don’t specify what you want done with it) are often are shifted into money market funds, where fees can outpace returns, eating into principal.
If you plan to roll over your 401(k) to a mutual fund or brokerage, make sure your new provider doesn’t park you in high-cost actively-managed funds or managed portfolio services. Instead, manage your portfolio yourself by creating a portfolio of inexpensive index funds or Exchange Traded Funds, available through the provider’s brokerage services.
“The fees you’ll pay will depend very much on the level of sophistication and services being offered,” Herman says. “If you need a lot of service and attention - like a managed portfolio - you will pay for it.”
Lump Sum Rollover Dangers
Traditional pension plans that offer lump-sum buyouts to workers are another emerging danger area.
A growing number of plan sponsors are offering these deals to terminated workers as a way of reducing the pension risk carried on their books. More than one in five (22 percent) sponsors say they are "very likely" to make lump-sum offers to former, vested workers this year, up from 14 percent in 2014, according to Aon Hewitt, the employee benefit consulting firm.
A U.S. Government Accountability Office report on lump sum offers noted that about half of the payouts are rolled over into IRAs and that workers “often received unsolicited financial advice, for example, from financial planners, investment advisors, or even other plan participants.”
Most pension beneficiaries will enjoy greater retirement security holding on to the guaranteed income stream and should avoid the temptation of IRA rollovers.