MONEY TALKS - Choosing what to do with your 401(k) account when you leave your employer can be one of the biggest financial decisions that you make over your lifetime. After all, your 401(k) account is probably the largest asset you own outside of your home. Determining where to invest your money is critical towards the success or failure of your financial plan. The right decision could net you hundreds of thousands of dollars in retirement income, while the wrong decision could lead to a retirement lifestyle that is far below your expectations. Here are some key factors that you should consider when deciding what to do with your retirement nest egg.
Organization – Consolidating old 401(k) accounts into an Individual Retirement Account (IRA) or your new employer’s 401(k) plan can be a great way to organize your finances. Current research indicates that the average employee may have 12 to 15 jobs over their lifetime. This could lead to multiple 401(k) accounts with different service providers. Consolidating these accounts allows for easier access and helps prevent old accounts from being lost or misplaced.
Transparency – When your investments are spread over multiple 401(k) accounts it’s hard to track the performance and allocation of your total portfolio. Furthermore, trying to properly balance an investment portfolio spread out over various accounts usually requires sophisticated software that most account holders don’t own. Consolidating old 401(k) accounts into an IRA or into your new 401(k) plan may provide more transparency by allowing you to see all of your investments in one place.
Automation – Many 401(k) plans have automation options to help the plan participants save more and manage their investments more efficiently. One of which is known as an auto-increase. Each year, for those employees who enrolled in the program, the auto-increase will automatically raise their contribution percentage by a specified amount – often by 1%. Another automation option is auto-rebalancing. Participants enrolled in this feature will have their asset allocation (how much you have in stocks and bonds) automatically adjusted either quarterly or annually. These features are a great way to increase your savings while keeping your portfolio aligned with your goals. Unfortunately, these perks aren’t typically available for IRA accounts or 401(k) accounts once the employee has left the company. As a result, you may want to consider rolling your investments into your current 401(k) plan.
Fund Selection – The type and number of mutual funds available in 401(k) plans vary dramatically by employer. While the average 401(k) plan has 28 options, some 401(k) plans have as little as 5 options. On the other hand, large employer plans may offer 100’s of options. Yet, if selection is what you are looking for, then rolling your 401(k) plan into an IRA might be your best option. An IRA held at a large custodian such as Fidelity could have north of 10,000 mutual funds to choose from. That being said, before making the switch, be sure to look at the specific funds within you plan. While more options may appear to be the better solution, you could be leaving money on the table by exiting your plan. Some 401(k) plans have stable value funds designed to protect your principle balance while generating yields that have historically outperformed most money market accounts. While most IRA’s don’t offer this option, check your old 401(k) accounts as well as your new 401(k) plan for a stable value fund before moving any money.
Fee’s – Although they are not itemized on your account statement, each mutual fund has expenses such as distribution fees, management fees, administrative fees, operating costs, and other asset based costs, that are incurred by the fund. These costs, often collectively referred to as the expense ratio, are then passed onto the investor. Unfortunately, these expenses cut directly into your investment returns and can have a major impact on the long-term performance of your portfolio. Before rolling over any assets, be sure to look at the expense ratios of the mutual funds within your old 401(k) accounts as well as your new account. If your former employer plans qualifies for institutional rates with low expense ratios, then you may want to leave the money be. Otherwise, you should consider rolling the money to a lower cost option such as an IRA or your current 401(k) plan.
Exit Routes – If you are retiring then you may want to look into your plan distribution rules before deciding whether to leave the money in your 401(k) or rollover to an IRA. Most retiree’s want the flexibility of monthly withdrawals; however, some workplace plans only allow for annual, semi-annual, or quarterly distributions. In contrast, IRA’s are extremely flexible and let you decide when you want to take your distributions. However, there is a caveat; if you are 55 years old or older in the year you leave your job, you can take a penalty free distribution from your 401(k). Whereas you can’t take a penalty free distribution from an IRA until reaching age 59.5.
Understanding your options and using a prudent level of care is more important now that ever. Each 401(k) plan is slightly different including the specific investment options available to you. Be sure to take the time to understand the nuances of your plan(s) before deciding whether to let it be, rollover into an IRA, or move to your new employer’s 401(k) plan.