Trillions of dollars in 401(k) assets are on the move as employees retire or change jobs. It’s not difficult to transfer these funds, but there’s a lot you need to know to avoid getting fleeced.
Hundreds of financial service companies are overcharging 401(k) investors to set up Individual Retirement Accounts (IRAs). Investment and brokerage fees that they charge can quickly devour your nest egg. This massive marketing pitch is accelerating as some 10,000 Americans daily turn 65.
According to the non-profit Pension Rights Center (PRC), “members of 401(k) plans typically become eligible to withdraw plan assets when they leave an employer, reach age 59 and one-half or when otherwise permitted by the plan.”
The most essential first step is the knowledge that you don’t have to make a move. Do you like your employer’s plan? You can leave your funds in your present plan, but if you cash out the balance it will trigger income taxes and a 10% penalty — if you’re under age 59 1/2.
Keep in mind that 401(k) plans usually offer mutual fund choices that offer lower fees than IRA selections. This is particularly true for large plans. According to a 2022 study by The Pew Charitable Trust, the median expense ratio for institutional mutual fund shares (low-cost funds usually offered in employer-sponsored plans) was 37% lower than those for retail shares (offered by most IRA custodians) for stock, bond and hybrid funds—those investing in a mix of stocks and bonds.
The best way to transfer your funds is to find a low-cost money manager that’s not trying to sell you something or layer on exorbitant fees. This usually means avoiding brokers, financial “consultants” and insurance companies. If a company is pitching you directly, avoid them.
Here are some other key guardrails suggested by the PRC that will help protect your money:
- Diversify. Plan administrators for 401(k)s are “legally required to provide plan members with diversified investment choices and to monitor the performance of those investments. IRA custodians don’t have to do that and rarely—if ever—do. Does the plan offer an adequate investment menu of non-correlated stock and bond funds (Financial researchers say that maintaining a proper asset mix can reduce investment volatility).” What’s a diversified mix? A broad array of domestic and international stock and bond index funds.
- Consolidate. Transferring plan assets can make sense in some situations, such as consolidating plan assets in one place, to convert assets to a Roth IRA, or if a plan’s fees are high and/or plan choices insufficient. If you do a Roth conversion, you will likely have to pay Uncle Sam for taxes due.
- Vet Fees and Expenses. How do your 401(k) plan’s investment and administrative fees compare to prospective IRA fees? (IRA fees are often higher). Your best bet to keep expenses low is to avoid actively traded and proprietary (”in-house”) funds.
- Compare Returns to Indexes. Made up your mind to do an IRA transfer? How do the new fund’s investment returns compare to the performance of the standard index representing each fund’s specific investment-strategy-benchmark? (Compare various time periods).
- Will state law protect your IRA from creditors? Leaving a 401(k) plan means losing many federal protections, such as the general insulation of plan assets from creditors. Talk with an estate planning attorney if this is a concern.
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