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If you’re leaving your job for a new employer, you must decide what to do with your 401(k) account. To keep growing your savings tax-free until retirement, you could have up to 3 options: keep it where it is, roll it to a new employer-sponsored plan, or roll it to a personal IRA. It’s important to make an educated decision. Otherwise, you risk making your dream retirement more expensive than necessary.
Unfortunately, you can’t count on IRA providers to make this decision any easier. In a 2013 study, the Government Accountability Office (GAO) found that financial institutions push IRAs when 401(k) participants ask about their account options. This finding is hardly surprising once you understand IRAs can be highly profitable and that providers are often under no legal obligation to give impartial advice – leaving them free to push IRAs that are in their interest, not yours.
Given the pervasiveness of conflicted 401(k) rollover advice, I recommend you learn how to make an educated rollover decision yourself. Below are the factors you should weigh. In general, they fall into two categories - account features and fees.
401(k) vs. IRA features
401(k) plans and IRAs have different investment and distribution features. Before weighing the cost of your account options, I recommend you understand these differences. Otherwise, you could forfeit a valuable feature by choosing one account type over the other.
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401(k) Plans |
IRAs |
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Investment options |
Limited to a lineup of “prudent” funds that allow participants of any age to appropriately invest their account. A fund is prudent when it meets its investment objective (e.g., track the S&P 500 index) for reasonable fees. |
Nearly unlimited investment options. However, IRA providers are under no obligation exclude imprudent (overpriced) investments. |
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Pre-retirement distributions |
A lump sum distribution is typically allowed upon separation. Partial distributions may also be allowed. |
Distributions may be allowed for any reason. |
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Taxation rules |
Distributions are taxed as income unless rolled over. Mandatory 20% income tax withholding applies to rollover-eligible distributions. |
Distributions are taxed as income unless rolled over. No mandatory income tax withholding at time of distribution. |
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Early distribution penalty |
Generally, distributions from IRAs and 401(k)s prior to age 59½ are subject to a 10% early distribution penalty unless an exception applies. 401(k) and IRA exceptions differ. |
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Must commence at age 72. Non-5% owners can delay until separation. |
Must commence at age 72. RMD rules do not apply to Roth IRAs while the owner is alive. |
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Creditor protection |
Participant accounts are protected from most creditors under the Employee Retirement Income Security Act (ERISA). |
No ERISA protection, but up to $1 million protected under federal bankruptcy law. Limit indexed for inflation every 3 years. Effective April 1, 2019, the limit is $1,362,800. Additional state protections may also apply. |
401(k) vs. IRA fees
Just like 401(k) fees, IRA fees can vary dramatically. That means you can’t just assume your 401(k) option(s) will cost less than an IRA, or vise-versa. Instead, you must compare their fees on an apples-to-apples basis to determine your lowest cost option. 401(k) and IRA fees come in two basic types - administration fees and investment expenses.
- Administration fees - are paid to the 401(k) or IRA provider for account maintenance. They can be paid directly by account deduction or indirectly from investment expenses.
- Investment expenses – are paid to the investment provider – usually a mutual fund company. Mutual fund companies often make their funds available in multiple share classes, each with different investment expenses.
Below are some key 401(k) and IRA fee differences:
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401(k) Plans |
IRAs |
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Investment expenses |
There are two general forms. Shareholder fees apply to individual investor transactions and account maintenance, while operating expenses cover regular and recurring fund expenses. Fund companies can add revenue sharing and sales loads to investment expenses to pay 401(k) or IRA service providers. |
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Administration fees |
May not apply if paid by the plan sponsor. Otherwise, fees can be paid directly by account deduction or indirectly from investment expenses. |
Always paid by the investor – either directly or indirectly. |
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Share classes used |
Share classes specially designed for employer-sponsored retirement plans are most common. Typically, they cost less than retail share classes. |
Retail share classes are most common. Less costly share classes may be available to investors with large balances |
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Fee disclosure |
Participant-directed plans are subject to DOL fee disclosure requirements intended to make fees easier to understand and compare. |
Not subject to DOL requirements. Mutual fund prospectuses usually the only source for fee information. |
John Turner is a former Deputy Director of the DOL’s pension research office. In 2014, he posed as a former federal employee with $200,000 invested in the Thrift Savings Plan (TSP) – a 401(k)-like plan that covers federal employees. He called representatives of 15 financial institutions and asked them what he should do with his money – keep it invested in the nation’s largest and lowest cost savings plan - or roll it over into an IRA with the financial institution. Unsurprisingly, 11 of the 15 companies advised him to rollover his TSP account, a move that would have cost thousands of dollars in higher fees over 10 years.
Moral of the story? Know your 401(k) rollover options. It can be EXTREMELY difficult to find impartial professional advice today. That means you want to be able to weigh your options yourself.
