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Why a 401(k) Rollover to an IRA is Not Always the Right Answer

NEW YORK (MainStreet) Some $6 trillion is held in IRAs, almost half of which were funded by the transfer of assets from employer-sponsored retirement plans like 401(k)s. These rollovers feed the profits of banks, brokerages and advisors who sponsor workshops, "lunch and learns" and premium steak dinners to lure pre-retirees to transfer their assets. Nearly two-thirds (64%) of IRA owners consulted with a financial advisor before making a decision regarding a rollover.

Also See: 5 Common Mistakes 401(k) Investors Make

But is a rollover really the right decision? Is a transfer of your at-work retirement savings from a 401(k) to an IRA an escape from limited investment choices, high fees and poor performance? While millions of marketing dollars are spent to convince you of just that, the reality is not quite that simple.

Investors face four options

Usually there are four options when a 401(k) plan participant retires or otherwise leaves an employer: cash out the value, rollover the assets to an IRA, rollover the assets to the plan of a new employer or leave the money in the former employer's plan. There are tax and possible penalty considerations, as well as fees, investment options and retirement needs to be considered with each choice.

Preserving the tax-deferred (or in the case of Roth arrangements, tax-free) treatment of retirement savings is the primary reason investors rollover their accounts to an IRA, according to 2013 research conducted by the Investment Company Institute. Many investors (68%) say they simply didn't want to leave their assets with the former employer. The often-mentioned desire to gain more investment options was noted by 61% of IRA owners. And more than one-third (35%) of the investors said they "were told by a financial advisor to rollover the assets."

Also See: Maximizing Retirement Savings Through Smart Tax Planning

Since maintaining the tax advantages of retirement savings is a primary goal of investors and can be achieved by either leaving the assets in a 401(k) or transferring them to an IRA there is no advantage to a rollover in that regard. In fact, required minimum distributions (RMDs) are triggered at age 701/2 for both options unless you are still working. In that case an RMD from the 401(k) is generally not required. Advantage: 401(k).

More is not always better

Having more investment choices can be a good or bad thing. Investors struggle mightily to decipher 401(k) investment menu choices; having an unlimited number of options to consider can be even more overwhelming. And 401(k) plans often have another advantage: lower-cost institutional funds. These are investments sold "wholesale" in bulk to large investors, like 401(k) plans, that aren't available to retail account holders.

In addition, the growing popularity of target-risk fund-of-funds, as well as target-date goal-based funds are helping investors to properly manage their investments with the selection of just a single fund. According to Vanguard research, nearly one-quarter (23%) of "do it yourself" investors who do not use such allocation funds hold "extreme" non-diversified portfolios -- 10% holding no equities, 13% holding only equities. Target-date or target-risk fund investors can't wander into such risky waters because the professionally managed options include automatically adjusted mixes of equity and fixed income investments.

Other reasons to resist a rollover

While the right decision varies with each investor, there are other reasons why a 401(k) investor might want to resist a rollover:

  • 401(k) plans often offer investment advice, financial planning assistance and educational workshops.
  • Generally, 401(k) assets are protected from creditors, judgments and bankruptcy proceedings. IRA assets are usually protected only from bankruptcy actions and IRA investment protection from lawsuits varies from state to state.
  • Investors holding high-profit company stock can trigger an ordinary income tax bill upon transfer to an IRA.

Rollovers can be the right decision, no doubt. But sometimes doing nothing can be something to consider, too.

--Written by Hal M. Bundrick for MainStreet

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