A Good Number of People Mess Up Their 401k Transition

Here's a piece from Marketwatch that gives some interesting stats on what people do with their 401ks when they move to a new job. The choices are to leave the money with their former employer, transfer the money to their new employer's plan, roll over the money into an IRA or cash out. Here's what they do:

Some 7.5 million Americans took about $440 billion in distributions from their 401(k) plans in 2004, according to Brightworks Partners research. Of the 7.5 million, 6.25 million were job changers and 1.25 million retired. Of the 7.5 million, 55% had 401(k) balances greater than $5,000.

Where did the money go? About 45% -- representing some $200 billion -- rolled their 401(k) into an IRA, while 32% left their money in their former employer's plan, 20% withdrew the money and paid the taxes due on that distribution, 9% transferred their money to a retirement plan at their new employer and 6% purchased an annuity or arranged to have the money paid in installments over a period of time.

My thoughts on these:

1. Rolling over to IRA -- Good idea. In fact, it's my preferred method for what to do with a 401k when I shift jobs.

2. I never understood why people leave their money in their former employer's plan -- other than it's "easy." You're moving companies, you have no contact with them on a regular basis, the fees are likely more costly than an IRA, and you have no influence if something goes wrong (I think the HR department is more inclined to take care of current employees than former ones.) So what's the advantage? Do they somehow have great investments that you can't get in a Vanguard IRA? Someone enlighten me, please.

3. Cashing out is a big, big mistake -- doing it can kill your retirement savings plans.

4. Transferring to the new employer's plan isn't a bad idea -- but I still like #1 better. You get more control and probably lower fees with option #1.

5. Don't get me started on annuities. They are another money mistake (at least in most cases.)

Comments

[HP]

In response to point #2 ("Do they somehow have great investments that you can't get in a Vanguard IRA?")...

There are some "popular" mutual funds (mostly due to their long-term performance... American Funds Growth Fund of America, for example) which would normally have front-end or back-end loads or 12b-1 fees, but in an institutional plan, because of the large amount of assets in the plan, the plan can negotiate to get a special "institutional-only" share class that doesn't have these fees.

Other funds may be closed to new investors (Dodge & Cox Stock, for example), but a 401(k) plan participant that is in a plan that offers this fund can still invest in it.

Finally, company stock funds in a 401(k) plan would be another reason why a participant might want to leave money in their former employer's plan. When a participant "cashes out" company stock but distributes the stock share "in-kind" rather than selling the shares for cash, the participant would only owe income taxes (and penalty, if applicable) on the cost basis for the company stock. If this company stock has appreciated a great deal, it may be to the participant's benefit to distribute the shares in-kind, hold them in a taxable brokerage account for a while, and then pay capital gains taxes on the appreciated amount at a later date. In this example, the participant may want to hold off distributing all of the company stock to spread out the taxes that would be owed on this cost basis.

Still, these are pretty isolated examples. You're right in that most cases, rolling over to an IRA would be best. However, there are many institutional plans that do not charge fees even for former employees.

[Mark]

I have about $125k in the federal government's 401(k), called the Thrift Savings Plan (TSP). TSP offers fund choices that mimic the SP500, Wilshire 4500 and MSCI EAF indices.

They charge fees of .03-.05%. Compare this to Vanguard's SP500 (in which my Roth IRA is invested), which has fees of .18% and are widely considered to be the cheapest in the industry.

And it's not as if they are going to go broke anytime soon.

[Lazy Man and Money]

The other thing I can think of with the #2 above is that you don't often need to talk to your former company. I would deal directly with the financial organization holding the 401K. I'd say it's out of laziness (which is big with me), ignorance (401Ks are not very transparent with their fees making you think they might not be any), or good reasons such as the circumstances that Mark mentioned.

[Matthew Amster-Burton]

I've left some money in my former employer's pension because I'm about 65% vested, and if I should ever go back to work for them for a couple of years, even part-time, I would end up with a huge benefit from becoming fully vested. That's obviously a different situation than a 401(k), though.