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Thinking about rolling over your 401(k)? Make sure you do your homework first.
Getting advice is easy. Just look on the internet and you’ll see opinions everywhere. But before you make any moves, you should ask yourself: “Does this advice benefit me or someone else?” This is important because your 401(k)’s performance will impact your quality of life during retirement. So it’s crucial to make sure this key asset is protected and poised for growth.
Here’s what you need to know about transferring a former employer’s pretax retirement plan.
Is a rollover right for you?
Once you’re no longer with an employer, you need to decide whether you want to leave your 401(k) where it is, or move it from your former employer’s plan into an IRA. Though it’s usually up to you, sometimes, such as when a balance is small, the option to leave your money may not exist.
No matter what situation you find yourself in, give careful consideration to whether rolling your investment is a sound strategy. There are countless brokerages, banks, mutual fund providers, and insurance companies who are more than happy to roll your money into their products. Before you initiate a transfer, make sure you understand how the product offering fits your overall financial plan, and that it isn’t just a sales tactic.
Expand investment possibilities with new options
With your own IRA, you’ll expand your investment options. One of the drawbacks of employer selected funds is that you’re generally limited to just a few choices. Rolling over is often beneficial, therefore, in that the types of investments you can make opens up widely. While having more choices can provide you with new opportunities, be wary of financial service providers who are overly interested in their commissions. An advisor’s goal should be portfolio growth, not draining your principal with excessive transaction costs.
Whether you work with a mutual fund company directly or an advisor will in part be determined by the size of your rollover. Balances under $100,000 are often not large enough for fee-only advisory firms. If that’s the case, and you do need to work directly with a mutual fund, determine the fund’s fees, commissions, and investing strategies upfront. Morningstar.com is a great place to start your research.
Working with a fee-based advisor, however, is preferable when possible. That’s because back-end and upfront costs are minimized—and it’s easy to monitor results. These types of arrangements are also beneficial because your advisor is incentivized to grow your account—meaning he or she grows when your account does well. Additionally, the right advisor can help you navigate the ups and downs of market volatility, which is crucial if you’re unable to expertly manage your account on your own.
With a $100,000+ balance, new possibilities will open up. Fee-only advisors will now be able to work with you. An advisor who provides frequent updates on investment returns and regular advice is the professional you should aim to work with. You should always feel as though your advisor is guiding you toward maximum return on investment and helping you figure out what kind of lifestyle you can have in your golden years, while minimizing the risk you’ll outlive your resources. Something to keep in mind is that the best portfolios aren’t just left on their own. They are constantly massaged by professionals who anticipate changing markets, and who have a game plan to adapt.
Outstanding loans can eat up principal if you don’t pay them first
While moving your 401(k) to an IRA is generally a good idea, you may want to leave funds in your employer’s plan if you have taken a loan.
Some plans offer participants the ability to borrow against their balances, making repayments via deductions from their paychecks. Once no longer with an employer, borrowers must continue making payments. Failure to do so can result in loan forgiveness which becomes reported as income. If you find yourself in this situation, you’re going to have to pay taxes. On top of the income taxes you’ll need to pay for the loan amount, you may also be hit with a 10% penalty for an early distribution from the IRS.
Rather than paying nearly half your outstanding loan balance in state and federal taxes, it’s better to leave your 401(k) with your employer until your balance is paid off. You can’t keep your loan status if you rollover. So wait until your loan is paid to help preserve the principal.
You should also check with your advisor on what’s called a Net Unrealized Appreciation if you’re taking funds out of a 401(k) that’s invested in an employer’s stock. This may help you determine whether there are rules to reduce your taxes in the event of a large capital gain.
Don’t get blind-sided by the illusion of lower costs
If you’re trying to save money by just leaving your assets in your employer’s plan, you might want to think again.
While you may get out of some of the management costs associated with a newly, rolled over 401(k), chances are, you might be missing out on bigger picture gains. Rather than management costs, long-term investment performance is where your focus should be. The truth is, most employer 401(k)’s offer little guidance. They simply give you a few options, provide a couple of bullet points on past performance, and turn the reigns over to you—without any real indicators of how to measure results. So while you might save a few pennies in the short-term, your principal may suffer from an inability to grow at an appropriate rate. A qualified professional can often help you improve on this performance.
With careful research and a qualified advisor, you can implement a sound strategy for maximizing your principal when rolling your 401(k) over.
