Bloomberg News recently wrote about brokers profiting by advising retirees to roll their 401(k) accounts into IRAs. Many of the retirees interviewed said they lost a lot of their savings from investments subsequently recommended to them. But this doesn't mean you shouldn't consider transferring your 401(k) money into an individual retirement account (IRA). Here's how to decide:
First, a little background. A 401(k) account is an employer-sponsored plan that allows the employee to save and invest, typically receiving a tax benefit when the contribution is made, though taxes are paid later upon withdrawal.
A related investment option, the Roth 401(k), has no tax deduction upfront when the contribution is made, and withdrawals in the future are tax-free.
The choices of mutual funds within a company's 401(k) generally are limited, and upon leaving your job, you can roll the account over to an IRA and owe no taxes for the move. Brokers and financial planners don't make money from 401(k) accounts, so it may be self-serving to tell clients to roll over funds to an IRA, through which they can either sell clients a high-priced product or charge them a percentage of the total assets under advisement every year. Remember, it's not the number of choices in your 401(k) that matter, it's the quality of the choices.
Vanguard founder John C. Bogle, like Chicago-based investment research company Morningstar, has demonstrated that generally, the higher your costs, the lower your returns. If a broker or adviser is telling you to switch your 401(k) into an IRA, be sure to ask about the fees, which may be high relative to other options. However, rolling over your 401(k) to an IRA composed of ultra-low-cost index funds may be right for you. An index fund is a mutual fund that typically owns a broad basket of stocks or bonds and has fees as low as 0.04 percent annually, which translates to $4 per year on a $10,000 investment.
So step one is to determine the fees in your current 401(k). Morningstar is a great place to look. Typically, your statement will give the name of your funds and a symbol, such as RYSYX, which is the Rydex S&P 500 fund. Don't assume all index funds have low fees, as this fund charges a 2.32 percent annual fee. Enter that symbol into the Morningstar page and you will see a description and the expense ratio. If your expense ratios are 0.40 percent or more, consider rolling the funds into an IRA. Even if your expenses are below 0.40 percent, you may want to roll over the funds if you can save in fees.
If your 401(k) from your former company has only high-cost choices, then move on to step two and consider switching your 401(k) to companies such as Fidelity, Schwab or Vanguard. They all offer lower-cost index funds. Ask your new firm to do a "trustee-to-trustee" rollover, and make sure it doesn't withhold 20 percent of your funds for taxes.
You've worked hard to accumulate assets, and your portfolio can now serve as stored energy to help you live better. Don't let others profit from your money. If you lower your fees by 1 percentage point annually, it's like making an extra $1,000 a year on a $100,000 portfolio.
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