401ks are great ways to save,but when you leave a job,you have to decide whether you should leave your savings in the 401k or roll it over to your own IRA.Rollover contributions are increasingly popular,and they're expected to increase at a compound annual growth rate of 5.5 percent,reaching nearly $470 billion in 2018,according to data from Cerulli Associates.
Converting 401k assets to an IRA makes sense when workers leave a job because it allows them to have greater control of their money by separating it from an employer relationship and allowing self-directed investments.
The trend is largely fueled by the tendency of Americans to job-hop,especially younger workers.The most recent data released by the Bureau of Labor Statistics found that employees tend to stay with their current employer an average of 4.6 years,leaving a question mark around what to do with retirement savings vested in a 401k plan.
Martin Shapiro,Harvard MBA and author of2039,recommends rolling over savings to a Roth IRA at a high quality mutual fund company if you are young,have minimal savings,your tax bracket is low and you qualify.
Unlike other IRA options,the Roth distributes savings tax-free when it comes time to retire.Some 40 million American families have savings of more than $7 trillion parked in IRAs,according to a 2015 White House Council of Economic Advisers (CEA) study,and the majority of that money was transferred from 401k plans.
"When workers don't manage retirement savings correctly when switching jobs,they could end up with a large,unnecessary tax bill and investments that do not meet their goals,"said Larry Rosenthal,CFP and president of Rosenthal Wealth Management Group in Manassas,Virginia.
Further complicating the decision of whether or not to roll over 401k,457 and 403(b) assets is its speculative nature."Investors should always opt for the alternative that offers the best risk-adjusted return,"said James Dowd,chartered financial analyst and CEO of North Capital,a registered investment advisory firm in Utah and California.
Once rolling over to an IRA is decided upon,pundits recommend that employees make like kind transfers,which are tax-deferred 401k to tax-deferred traditional IRA or Roth 401K to Roth IRA.This gives the taxpayer maximum flexibility since traditional IRAs can always be converted to Roth IRAs.
Although cashing out 401k assets is tempting,there's a 10 percent federal penalty for those who do so before the age of 65,and the entire proceeds will be taxable in that year of withdrawal as ordinary income."If the amount is substantial,it could bump you up to a higher tax rate or put you into an Alternative Minimum Tax position for the year,"said Shapiro.Cashing out early is a desperate action and should only be done in emergencies.
Rolling over 401k savings from a former employer to an IRA doesn't preclude workers from making contributions to both an IRA and a new 401k with a current employer."What most people don't realize is you can contribute to your company 401k and your new IRA,which gives even more same year tax deduction on your income,"said Stephen Gardner,author ofA Bridge Over Troubled Wall Streetand founder of the Safe Millionaire Club in Salt Lake City.
The downside of leaving money behind upon quitting a job is a matter of management,because even the sharpest people can simply forget where their money is when it's not rolled over to a personal IRA."If you leave retirement accounts at three or four jobs over 10 or 15 years,that's three or four accounts in different places to keep track of,"said David Weliver,founder of the websiteMoney Under 30.
Another challenge of leaving money behind is beneficiary status in the event of death."If the investor dies,the question becomes what happens to the bundle when it comes to spousal and non-spousal beneficiaries,"Rosenthal said.
Rolling over retirement savings,however,can also be an opportunity to avoid excessive investment expenses by eliminating the middle man and investing yourself in IRAs at platforms,such as Vanguard,Ameritrade or Fidelity,because most 401k plans invest in mutual funds that have a greater than 1 percent expense ratio.So,investing in lower cost funds on your own can reduce expenses.
Lower fees mean a lower performance drag."The opportunity to invest in superior funds and improve expected returns through diversification are also compelling reasons to move 401k savings to an IRA,"said Dowd.
For the lazy investor,if the funds are invested in a low-cost allocation 401k plan,allowing savings to age in place may be a painless option but it offers no long term opportunity."Most of the unique benefits of employer-sponsored plans,like the ability to take out a loan against the account or the ability to make contributions,are terminated when an employee leaves the company,"Dowd said.
Besides,leaving money behind can lead to surprises when retirement plan administrators suddenly cash out accounts with small balances.Wilever cautions,"If you do nothing,you may one day receive an unexpected check minus income taxes and the 10 percent penalty."
By Juliette Fairley
About the Author
Juliette Fairley is a writer forTraditionalIRA.comandRothIRA.com.She is a Manhattan resident who graduated from Columbia University's Graduate School of Journalism.Her past incarnations include being a TV host for the Discovery Channel,anchoring financial news segments for TheStreet and writing for the New York Times and the Wall Street Journal.