Why You Really, Really Need to Roll that Old 401K into an IRA


The 401k management companies out there won’t like this post, because it reveals a secret that they would rather keep under wraps:  They make most of their money on the employees who have a lot of money in their 401k.  This means that if you’re a relatively new employee with just a couple of thousand dollars in the 401k, give a big thanks to the guy behind you who has been contributing for 25 years, because he’s paying most of the costs.  Because 401k plans and the mutual funds inside them charge a fee based on the amount you have invested, you won’t be paying much when you’re just starting out – the fund company is losing money on you – but they hope that some day your account balances will grow exponentially and then they’ll make back the money they lost during the early years and then some.
If you work for the same company all of your career, there isn’t much you can do about paying those fees.  You can’t move the money out while you’re still working with the company.  (and there certainly is some justification to let the fund company collect something for all of their hard work over the years.)  If you leave a company, however, you have the ability to roll the money into an IRA.  As long as you do it as a direct roll-over, it should be tax-free (actually tax deferred because you’ll pay taxes when you take the money out of the IRA at retirement) and you should not have any money withheld.  If the HR department cuts you a check and then you deposit it in the IRA yourself, you may well end up having money withheld that you’ll need to wait for tax time to get back.  (Note that all of this is really complicated and changes at times, so always, always, always verify everything with a CPA.)
Once your money is in the IRA, you will normally just have a nominal account fee each year of maybe $50 or $100, plus any fees on the mutual funds you buy.  If you put the money into index funds like SPDRs or other ETFs that track an index, such that there is very little cost for management, your fund management fees can be 0.25% or lower each year.  This can be a huge savings over the cost of portfolio percentage 401k management fees and the higher management fees the funds in your plan may charge.  You might also invest in a basket of stocks directly and only pay fees when you buy or sell in the form of commissions, but this can actually cost you more if you trade at all actively or you find yourself trying to time the markets.  Also, you need to make sure to buy enough different stocks to have sufficient diversification to protect your assets from single-stock risk.
So while many people have a thousand other things they would like to do than move their 401k, moving the funds from an old employer plan into an IRA can save you a lot of money in fees, meaning hundreds of thousands of dollaars more at retirement.  (Note moving funds from an old 401k into a new employer 401k usually doesn’t make sense because you’ll still have the same fees and limited choice of funds.)  How can you decide if it’s worth your time to make the move?  Look at these things:
1.  What are the account maintenance fees on your 401k?   Are they a percentage of the balance?  An IRA at a full service broker would cost $100-$150 per year.  A discount broker would be even less.  If you don’t have much in the 401k, it may be better to stay where you are.  Compare the fees your paying with $150 for an IRA account.
2.  Do you have the choice of low fee index funds, or are they all high fee managed funds?  You want funds with fees of 0.25% or less per year — ideally things like an S&P500 Index fund.
3.  Do you have a wide choice of investments?
4.  Do you think it might be difficult to find HR for an old employer by the time you retire, or is it just difficult to keep track of all of those different plans?
5.  Most important, is a lot of the 401k in the old employer’s stock?  Some companies pay their portion in stock, which will cause you to have way too much of their stock in your retirement portfolio.  You don’t want stock in any company to equal more than maybe 5-10% of your portfolio.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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