If you are leaving a job or retiring, you are often encouraged to transfer your 401 (k) retirement account or other work retirement account to an individual retirement account. It may not be the right decision.
Workplace plans have rules that can protect you from inferior investments and advisers who put their own interests ahead of yours. IRA investments can be more expensive, which can result in less money to spend in retirement. Workplace plans can also provide easier access to your money.
IRAs generally offer many more investment options, a fact strongly emphasized by financial services companies who want your money. Rollovers are big business – The Investment Company Institute, a trade group, reports that households transferred $ 463 billion from employer-sponsored plans to IRAs in 2017, the latest year for which statistics are available.
But having more investment choices isn’t necessarily better.
“With a 401 (k), your options will usually be more limited, but your options will also be very much in your best interests,” says Dylan Bruce, financial services advisor for the Consumer Federation of America, a nonprofit consumer . advocacy group.
Why the fiduciary standard matters
You usually have a choice about what to do with your retirement funds when you leave a job, and an IRA rollover is just one way to preserve the tax-deferred status of money. Other ways include leaving the account where it is (your former employer must authorize this if your balance is over $ 5,000) or transferring the money into a new employer’s pension plan, if that is the case. plan accepts such transfers.
Most workplace pension plans are covered by the Employees’ Retirement Income Security Act, which places a fiduciary duty on the people and businesses that oversee the plans. Trustees are required to operate solely in the interests of participants and to avoid conflicts of interest.
In the past, advisers weren’t required to meet the same standards when recommending IRA bearings, although that is changing. The US Department of Labor is extending fiduciary coverage to IRA renewals, recognizing that financial service providers often have a strong economic incentive to recommend them even when they are not in an investor’s best interest. Bruce calls this “a really good development”, but it won’t happen overnight. Enforcement of the new rules will be rolled out in stages starting next year, Bruce said.
Workplace plans can cost less, deliver more
IRAs are sometimes touted as being cheaper than the 401 (k) on average, but this is often not the case. Since 2000, the cost of equity funds within 401 (k) has declined significantly, according to the Investment Company Institute. The average expense ratio for mutual funds in the United States in 2020 was 1.16%, while 401 (k) investors paid about a third of that amount, or 0.39%, on average. Expense ratios are the annual fees charged for operating and administering the funds.
Fees make a big difference in how your nest egg grows. Let’s say you invest $ 20,000 in a fund with an expense ratio of 1.16% that increases on average by 8% each year. After 40 years, you would have about $ 282,000. With a 0.39% fee, your balance would be almost $ 376,000, or a third more.
Accessing your money can also be more difficult with an IRA. You cannot borrow money from an IRA for more than 60 days, otherwise it is considered a taxable distribution. Any money you withdraw before the age of 591/2 is typically penalized and taxed, although the penalty is waived for some withdrawals, such as for higher education or first-time home purchase.
With 401 (k) s, on the other hand, you can start withdrawing money at age 55 without penalty if you no longer work for the company offering the plan. If you are transferring an old 401 (k) account to a new employer’s plan, you can usually borrow up to half of your total vested balance or $ 50,000, whichever is less, and pay the money back. over five years.
In addition, your 401 (k) is also generally protected from creditors. Protection for IRAs varies depending on state law.
When a reversal makes sense
A lot of people don’t want to leave money with their former employer, and a rollover is a much better option than cash out. A rollover may also be prudent if you don’t have access to a low cost 401 (k), if you want to consolidate multiple retirement accounts, if your investment options are too limited, or if the advisor recommending the rollover is a trustee. (and willing to put that in writing).
However, it is essential to study all of your options before deciding that an IRA rollover is the right one. This is, after all, the money you hope to support yourself for many years in retirement, so choosing wisely is important.
“It will probably be one of the most important financial decisions of their lives for most people,” says Bruce.
This column was provided to The Associated Press by the NerdWallet personal finance website. The content is for educational and informational purposes and does not constitute investment advice. Liz Weston is a columnist at NerdWallet, a certified financial planner and author of “Your Credit Score”. Email: [email protected] Twitter: @lizweston.