What should I do about my old 401 (k) account?
The fiduciary standard of the Department of Labor (DOL), which is set to be implemented in 2018, will increase scrutiny on financial advisors’ responses. Fiduciary duty is a rule that requires advisors to act in their clients’ best interests when providing retirement advice. It is designed to safeguard retirement funds against professionals who are looking to make money at investors’ expense and to ensure the advice they receive is the right one for them. Wealthspire Advisors has always been committed to fiduciary standards and believes that it is best to let clients decide on the future of their old 401(k) by discussing the pros and con’s for each option.
There are four choices:
Keep your money in the 401(k) you already have.
You can roll your 401(k), into the plan of your employer.
3) You can roll your 401(k), into an IRA or
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It’s important that you understand the similarities between 401(k), traditional IRAs, and their tax features. These accounts are both tax-deferred. This means the dollars in these accounts will not be subject to income taxes until they are withdrawn. Transferring money between tax-deferred account is not considered a taxable transaction. Roth 401(k), Roth IRAs, and Roth IRAs, are also tax-exempt, which means that the funds in these accounts never have to pay income taxes because they were funded after tax dollars. It is important to keep the tax status when transferring money between retirement accounts. Otherwise, you may end up paying twice as much tax!
Keep your money in the 401(k).
Most 401(ks) will let previous participants keep the balance they have in their plan. Retirement plans are always looking to expand their size, because they have more leverage with plan administrators the bigger the plan gets. To grow a retirement plan, it is important to allow former employees to stay in the plan. If funds are left in an older plan, they can be mismanaged, rebalanced infrequently, or even subject to increased fees. You may end up with multiple employer retirement plans if you work at different jobs throughout your career. This can make it hard to allocate your portfolio strategically and to avoid alienating previous accounts.
Transfer your 401(k), or other retirement plan, to the current employer’s plan
Rolling your existing 401(k), if your new employer offers one, into the new account may make sense. This will allow you to combine your plans for retirement into a single plan. The elimination of accounts simplifies your portfolio and allows you to save money by avoiding required minimum distributions from an IRA. 401(k), however, is not covered by the IRA aggregate rule relating to Backdoor Roth IRA, which can be a good saving strategy for those with high incomes.
You must first verify whether the current plan allows rollovers, as they aren’t required to. The next step would be to determine if your 401(k), allows rollovers. Participants in employer retirement plans must be offered a wide range of diverse investments. This standard requires a minimum of a stock, bond, and money market funds, although most plans provide more. Many 401(k), however, offer passive index funds that are low cost and suitable for retirement saving. Many retirement plans offer expensive active-managed fund lineups that charge more than 1% per year, or index funds which cost up to 15 times as much as the index fund bought outside the plan. Investors should be aware of this red flag before rolling their previous 401(k). Investors should also evaluate administrative costs, which can vary by plan.
Transfer 401(k), IRA or other retirement plan into an IRA
Investors transfer their 401(ks) into a Rollover IRA because of a number of reasons.
- IRA Rollovers are widely accessible and easy to use.
- The investor can consolidate the employer retirement account over time.
- You can manage your own IRA or hire a professional to do so.
- These funds offer a wider range of options for investment.
This last point is important, as if your 401(k), for example, has a lackluster selection of options, you can use the Rollover IRA to buy low-cost, index funds or best-in class actively managed funds. You can also purchase individual stocks and qualified annuities.
There are some disadvantages of rolling over funds to an IRA.
- At age 70, you must begin withdrawing a certain percentage of your IRA funds.
- Contributions to a Roth IRA made through a back door would create taxable income.
Depending on where you live, a 401 (k) offers a great deal of creditor protection. A Rollover IRA does not. If you have a very high income and work in an industry with a lot of legal risks, this could be something to consider.
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This is without a doubt the worst option. The ordinary income tax is always applied to funds withdrawn from traditional 401(ks) (non Roth). You could accidentally be bumped up to a higher bracket if you withdraw a large amount. If you’re younger than 59.5, you may also be charged an additional 10% early withdrawal fee on top of your income tax – except if the work stopped in the year that you turned 55.
There are a number of factors that you should consider before deciding how to dispose of an old 401 (k). Good advisors will guide you through the process of evaluating pros and cons for each option to help determine what is important to you.
