NEW YORK (MainStreet) — If you’ve left your previous employer, there is little reason to keep your cash in your old 401(k). Instead you should roll it into an IRA.
The benefits far outweigh the drawbacks, says John Lindsey, CEO of Lindsey & Lindsey Wealth Management in Westlake Village, Calif. Unless the expenses are significantly lower in the existing 401(k), there is no reason to leave your hard-earned money behind in that 401(k).
“Let’s say for example that Fidelity has the 401(k) plan for the company you work for, XYZ Co.,” he says. “When you leave XYZ, the firm is going to work hard to have you keep your assets in the plan or roll them into an IRA at Fidelity, which is most often the case.”
Of course, many employees discover they don’t know what the expenses are for their old 401(k) from a former employer, Lindsey says. The hidden fees are particularly egregious, and the lack of control over retirement savings can be detrimental to consumers.
Hidden Fees Add Up Quickly
The first set of fees are the ones assessed by the mutual funds, and 401(k) plans are “notorious for using very expensive mutual funds often because the plan sponsor or the employer receives a credit against the fees they pay to manage the plan," says David Twibell, president of Custom Portfolio Group in Englewood, Colo.
“It’s almost always a good idea to roll over your 401(k) funds into an IRA when you leave a job,” he says. “You have more flexibility in how to invest, you aren’t subject to lockouts and other annoying administrative issues and you can avoid the additional fees often associated with 401(k) plans.”
The fees “can eat up nearly 30% of your retirement savings over ten years, even a seemingly small annual fee such as 1.27%, which is the average U.S. mutual fund fee,” says Mitch Tuchman, managing director of Rebalance IRA in Palo Alto, Calif.
“It benefits most investment firms and brokers to keep their customers blissfully ignorant,” he says.
A second category of fees are those that are passed through to the participants by the employer. They can vary quite a bit, because the company has wide latitude in deciding which fees to pass onto the employee participants, Twibell says. In some cases, the employer picks up all the fees, but more often than not the employee foots most of the bill.
The two fees can really add up to erode the retirement savings sitting in your old 401(k). What's more, some employees end up paying more than 2% in additional management and administrative fees by keeping their money in their former employer’s 401(k) plan; that's $2,000 in unnecessary fees on a $100,000 retirement account each year.
“Imagine someone who keeps their funds in their former employer’s plan for a decade or two, which happens more often than you might think,” he says. “Now we’re talking as much as $40,000 in unnecessary fees. There aren’t many people that can afford to throw away that kind of money for no real purpose.”
Greater Breadth of Investment Options
The majority of 401(k) plans have few investment options, so why limit yourself to “20 to 40 options for your investments... when you could have the whole spectrum of investments for a portfolio,” Lindsey says. Rolling your money into an IRA allows you to diversify beyond the limiting mutual funds offered in a 401(k).
“In a traditional IRA, you could have REITs, non-correlated investments, alternative investments and other assets to spread out your portfolio as opposed to having a very narrow field of what’s offered in a 401(k),” he says. “If you’re not working there any longer, your 401(k) shouldn’t be there any longer either.”
If you simply want a “plain-vanilla 401(k) with buy and hold options,” leaving the assets might be an option, says Matthew Tuttle, portfolio manager of the Tuttle Tactical Management Core U.S. exchange-traded fund in Stamford, Conn.
With the current market instability, “investors need more to be able to navigate the volatility," he says.
"The only way to access options like tactical strategies, smart beta and liquid alternatives are in an IRA,” Tuttle adds.
Since the market crashes of 2002 and 2008, investors have become “sick of giving back all of their gains every time the market goes down," Tuttle says. To boot, many 401(k)s, he says, “don't have any options for protecting against that except for bond funds that get hurt when interest rates rise.”
“Tactical and alternative options are the only things that have the ability to allow investors some or all of the upside while limiting or eliminating the downside,” he says.
Fewer Accounts to Manage for Retirement
Not only is it easier to manage your money when you have fewer accounts, you can also benefit from the power of compounding, Tuchman says. When you invest money into a fund that provides a rate of return, your money grows by that rate. That rate not only applies to the original amount invested, but also to the amount your money has grown from it.
“So, the more it compounds, the more you have,” Tuchman says. “The more you have, the more it compounds. It’s a beautiful cycle — one that can actually increase your investment returns eightfold over 30 years. That’s why it’s often called the ‘miracle of compounding.’ But it’s not really a miracle, it’s just math.”
More than the advantage of consolidating accounts for growth purposes, many investors prefer to have all of their retirement money in one location so they can avoid keeping track of multiple accounts at multiple providers, says Chris Battistone, a vice president of PNC Investments in Pittsburgh.
"There have been many instances of individuals literally forgetting that they had money in their accounts and the prior employer is unable to find the owner, he says. "The accounts may be turned over to the state after a period of time."
No Borrowing Options With IRAs -- But Potential Compromise
Rolling your old, dust-gathering 401(k) into an IRA is not a flawless strategy for all consumers.
One main drawback is that rollover IRAs do not allow you to borrow from them in case you need a sudden infusion of cash, unlike 401(k)s that let you borrow up to $50,000 or 50% of the balance, says Matt Markowski, a certified financial planner at Markowski Investments in Tampa, Fla. The loan is not taxed as long as it is paid back within five years, and the interest on the loan is paid back to your account and not a bank. If you need money from an IRA, you will be forced to take a distribution and pay the tax.
Another 401(k) advantage? Leaving money in your 401(k) means you generally have "broader" creditor protection under federal law for lawsuits and bankruptcy, says Jake Loescher, financial advisor with Savant Capital Management in Rockford, Ill. If you rollover the funds to an IRA, the creditor protection still exists federally, but all the states vary on what funds can be considered in a particular judgment, he says.
There's a compromise, though, to have the best of both worlds. A partial rollover can meet your retirement goals, especially if you need the income from your retirement savings immediately — like one of Markowski’s clients in Tampa who retired at the age of 57. She opted for a partial rollover after calculating how much money she would need during the next two years and left that amount in the 401(k). She was able to take distributions from that 401(k) with no IRS penalty, since a retiree can start taking distributions from a 401(k) starting at the age of 55. Once she turned 59.5 years old, she began to make withdrawals from her IRA to keep getting income.
“Doing a partial rollover in this case helped the client take advantage of professional management and a wide range of investment options while avoiding IRS penalties,” he says.
— Written by Ellen Chang for MainStreet