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RETIREMENT PLANNING

Rolling over to an IRA? Ask these five questions first

Sticking with an old employer’s 401(k) is sometimes the better choice

Published: May 14, 2015 06:00 AM

Rolling over a 401(k) to an IRA seems to be a retirement rite of passage, next to attending the farewell lunch and handing in your company identification badge. But if you have $5,000 or more in a 401(k), there’s no law that you must move it when you leave your company. Your plan may let you keep your money there indefinitely. You can even arrange for required minimum distributions starting at age 70½, the same as with an IRA.

Financial advisers, though, offer plenty of reasons for setting up IRAs, but sometimes there are reasons for sitting tight in a 401(k). Here are questions to consider:

1. Which investment lineup is better?

Opening an IRA exposes you to thousands of investment options. But if your needs are simple—and “keep it simple, stupid” is a worthy investment mantra—you may be able to craft a 401(k) portfolio that works just fine into retirement. On the other hand, combining several 401(k)s into one IRA makes your money—and your beneficiary designations—easier to track.

2. Will an IRA cost me less in fees?

The investment research firm Morningstar has reported that over time, low fees and expenses are strong predictors of good investment performance. A big, well-managed 401(k) plan may charge total fees that are lower as a percentage of your assets than an adviser’s fees. Big 401(k) plans also can obtain mutual-­fund classes with lower expense ratios—internal costs—than what you or your adviser could obtain. IRA account holders usually pay 0.25 to 0.30 percent per year more in fees than 401(k) plan participants, according to a 2011 Government Accountability Office study. What harm could 0.30 percent fee do? A $100,000 investment growing at 6 percent annually for 30 years would be $37,570 smaller when subject to a 1.10 percent fee vs. a 0.80 percent fee.

Flip side: By rolling over several 401(k)s, your total IRA assets may qualify for a lower adviser fee. Advisers typically charge more than 1 percent for balances of less than $1 million, less for bigger portfolios.

You’ll find your 401(k) fees in the annual fee statement your plan administrator is required to send you. Ask how an IRA under the adviser’s stewardship would cost less. “Will they be comfortable doing that? Probably not,” says Terry Dunne, managing director of the Rollover Solutions Group at Millennium Trust in Oak Brook, Ill. “But that’s a good place to start if you’re trying to do something in your best interest.”

3. What’s the cost of rolling over?

With a direct rollover from your 401(k) to an IRA, there are no tax consequences. But if the company handling your new IRA won’t manage a competitor’s fund from your 401(k), you’ll have to sell it to purchase something new. Ask your adviser about the cost of that transaction.

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4. Which option is more flexible?

With an IRA you have more control. You’re not subject to rules on how often you can trade, which might not be true with a 401(k). State law permitting, you have carte blanche on naming IRA beneficiaries; by contrast, federal law requires spousal permission to name others as 401(k) beneficiaries.

But there are rules that favor a 401(k). For example, folks who leave a job in the year they turn 55 or later can make a withdrawal from that employer’s 401(k) for any reason, without penalty. Withdrawals from IRAs before age 59½ trigger a 10 percent tax penalty, with a few exceptions.

5. Where can I save more on taxes?

Withdrawals from 401(k)s and IRAs are taxed the same. You must begin required minimum distributions from both by April 1 of the year after you turn 70½. (Exception: If you’re still working then, you don’t have to take an RMD from your employer’s 401(k)).

But a rollover of the company stock held by the 401(k) into an IRA does not carry that favorable tax treatment, says Jerry Love, a CPA and financial planner in Abilene, Texas. He gives the example of $5,000 in company stock purchased within a 401(k) that has appreciated to $20,000. Rolling over that sum into an IRA subjects all of it to the ordinary income tax rate at withdrawal. But transferring the $20,000 to a regular investment account—not an IRA—subjects only the original $5,000 to ordinary income tax. The remaining $15,000 will be taxed when you sell it, at a potentially lower capital gains tax rate. “It’s a great tax-­planning opportunity,” Love says.

—Tobie Stanger (@TobieStanger on Twitter)

Editor's Note:

This article appeared in the May issue of Consumer Reports Money Adviser.



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