What to Do with Your 401k Money: Roll It Over into an IRA

One of the oldest (and easiest to answer in my opinion) questions about 401ks is what to do with it when you move from one job to another. We've already discussed that the worst thing you can do is cash out your 401k. But what should we do with it? A reader asked Money magazine this question -- asking if he should roll over his 401k into an IRA or leave it where it is (in his old employer's plan). (BTW, there's another choice -- he could put it in his new plan.) Unfortunately, Money waffles a bit:

I think the answer largely depends on how the investment options, expenses and other features in the 401(k) plans at your present and future employers compare with what you can get at an IRA at a brokerage firm or mutual fund.

Wow, that's a big help.

I know that the answer to almost every money-related question is "it depends", but for me, this seems like a no-brainer. I've left three jobs now where I've had to move a 401k. In every case, I've rolled it over into an IRA at Vanguard. Why? I have more control, more investment options, and lower costs than any other option (leaving it where it is or going into the new plan). I think this will also be the case for the vast number of people reading this post.

The Money article does recognize some of the benefits in rolling over a 401k into an IRA:

One advantage rolling your money into an IRA has is a variety of choices. These days, most banks, mutual fund companies and brokerage firms have IRA rollover accounts that give you access to more fund choices than most 401(k)s make available. You can even set up a self-directed brokerage account if you like, and buy individual stocks.

Plus, the piece offers a pitch for index funds:

If, on the other hand, you use this greater latitude to your favor -- say, by investing in a lineup of index funds or other low-cost options -- you could very well end up growing your nest egg faster than you would by keeping your money in a sub-par or so-so 401(k) plan.

Regular Free Money Finance readers know how much I like index funds. ;-)

The article ends with a warning about cashing out your 401k:

One option you didn't raise -- perhaps because you rightly rejected it out of hand -- would be to simply cash out your 401(k). But taking the money and running with it would be a huge mistake. Not only would you be giving back a big portion of the payout in taxes and penalties, you would be short-changing your retirement by foregoing the appreciation you would earn on by rolling over your account.

Yep. It's just a bad idea. It's one of the 12 biggest money mistakes you can make (see #1).

For more on how to make the most of your retirement, check out these posts:

• Seven Hot 401k Trends
• Figuring Out Your 401k
• Retirement is More Expensive than You Think
• How Much Do You Need to Save for Retirement?

Comments

[Steve Mertz]

Free Money-even though you can't seem to keep a job, i think you give good money advice. Have a great week end! Steve

[FMF]

Ha!

Yeah, my wife calls it the "five year itch". :-)

[samerwriter]

On the more macabre side, if you die and the beneficiary on your 401k plan is not your spouse, it is quite likely that the beneficiary will be required to cash out the 401k en masse, taking a potentially tremendous tax hit in the process (these taxes are not subject to the $1.5M estate tax floor, because they are the beneficiary's income tax).

This may quite possibly completely negate any benefit you derived from the 401k in the first place. For example, let's say over the course of your life you have saved $1M in your 401k. You specify your child as the beneficiary. When you die, your child will realize that full $1M as income in a single year resulting in it being taxed at the highest federal and state income tax rate, regardless what your tax rate was when you saved it. In other words, you would have been better off not deferring taxes on that savings at all.

If, on the other hand, you rolled the 401k into an IRA than your child could roll your IRA into a beneficiary IRA and withdraw the contents over his or her lifetime.

[Max]

I rolled over a small 401K ($1100) into an IRA with a different company. I was charged a 25% penalty for the transaction. No one told me they would do that. Is this legal??

[FMF]

Anyone know the answer to Max's question?

[Max]

I just got an update on my 401-K roll over. My account was 1408, and the AIG/VALIC charged me $895 to do the roll over. That is obviously not the 25% I was told I would be charged if I simply cashed out, that's 64% (without any warning). How can this be legal?

[scott]

FMF,

They charged you $895? FOR WHAT? I would seek out the details for this transaction.

[Ben]

They shouldn't have charged you any fee, especially not any fee that large. Did you roll it over directly or did you get a check and transfer yourself? If you did the latter I believe if its not within 30 or 60 days you get charged the taxes on it and have to claim them back from the IRS.

Can someone answer this question - I don't have any IRAs because I'm over the income limits. But I can still rollover a 401k into an IRA right? Also, can you rollover over multiple 401Ks into the same IRA? For instance if I leave my current job and rollover the 401k into an IRA, then in my next job I get a new 401k and leave that job - could I rollover that 401k into the same IRA account I already have or would it have to be a new account?

[Kevin]

Ben - you can always roll over a 401(k) to an IRA regardless of income. You can do more than one into a single IRA as well. The only thing you aren't supposed to do is contribute to an IRA after it has been rolled over from another qualified plan (401(k) or other). But it doesn't sound like that would happen for you anyway.

Max - are you sure that wasn't withholding on the rollover or your unvested portion on employer contributions? I am not aware of any fees that can be charged to rollover your own funds. If it was withholding and you transferred the funds yourself, make sure to put the full amount into the IRA or else you will be charged penalties and tax on the amount withdrawn. But you will be able to claim that withholding just like it was from a W-2.

[ncf]

I am wondering if I would be better off rolling over my 401K into an IRA - whether I could stop the bleeding somewhat as to the loses right now - then withdraw small amounts from the IRA to CDs or something that is not losing money right now - I am 61 so I can withdraw even though I am currently working and contributing to the 401K?? The economy is just so bad right now - I am not sure and not trusting banks either for that matter anymore!

[Linda]

Great question. You really need to look into a company like New York Life. Depending on what type of IRA you roll it into, you can stop the bleeding. NYL offers a rider on their variable IRA that can prevent a loss of principal. Most people are unaware of this. In addition, NYL is not a stock company--their clients own the company. They make decisions on what's best for their clients. And no TARP money here...all of the financial rating firms still give NYL their top ratings. I'd definitely look into the financial ratings of any firm I was considering.