It happens to most of us. You change jobs and, say, five years later you change jobs again. As you progress through your working years, a breadcrumb trail of old retirement plans begins to accumulate. What options are available for these accounts as you transition?
In general, four choices present themselves:
- 1.) Leave your funds in the old plans (though not all plans permit this).
- 2.) Roll assets into the 401(k) of a new employer.
- 3.) Roll your assets into an Individual Retirement Account (IRA).
- 4.) Take the distribution as cash.
For simplicity sake, we’ll gloss over the fourth option and assume that the purpose of these funds is to save them for retirement. To receive the funds as a cash distribution requires that taxes be paid on the entire amount and, if under age sixty, an additional 10% penalty be paid on the balance. This would clearly defeat the purpose.
What, then, is the best remaining option?
Without analyzing a specific circumstance, the proper answer is that “one of the other three” might be your best route. While all could be viable depending on the situation, some generalizations can be made.
Understand that this is written from the point of view of someone with “a dog in the hunt” because Liberty Tree Asset Management makes revenue off rollover IRA accounts. With that gladly disclaimed, I will assert that rolling your old retirement plan into an IRA is going to be the best decision in most cases. The reasons for this are severalfold, but much of it comes down to fees.
Like most things, 401(k) plans tend to benefit from economies of scale. As a plan has more participants and/or more dollars invested, the total fees per participant tend to drop as expenses are spread across more individuals. The inverse is true, as well, with smaller plans averaging higher fees. That said, I focus here on the “small plan” category for 401(k) accounts as the majority of us participate in plans which have total investments of under $100,000,000.
As Investopedia reports on a survey published by BrightScope/ICI in 2020,
(https://www.investopedia.com/articles/personal-finance/061913/hidden-fees-401ks.asp) the average total fees for small plans “were between 1.5% and 2% per year, with plenty of plans with less than $50 million in assets paying more than 2% a year in fees.”
If measured by company size, as opposed to the size of the retirement plan, fees break down similarly. The 401(k) Averages Book (20th Edition) (https://www.401ksource.com/) reports that companies with two hundred to five hundred employees pay average total fees of 1.51% per year, and the costs increase sharply for smaller companies. Participants of plans with under fifty employees pay fees that average over 2% per year.
This comes as a surprise to many retirement investors in employer plans. In fact, despite the high fees that are common, 37% of those surveyed by TD Ameritrade (https://www.amtd.com/news-and-stories/press-releases/press-release-details/2018/Three-Quarters-of-Americans-Are-in-the-Dark-When-it-Comes-to-401k-Fees/default.aspx0 in 2018 believed that they paid NO fees.
Though 401(k) plans are required to publish their fees, finding them in complex plan literature is often beyond most participants. Many retirement plan savers interpret the lack of clearly disclosed fees as an overall lack of fees, so it is understandable to start with the mindset of not wanting to leave “free” investing.
Clients that have never worked with an experienced Financial Advisor may feel some initial sticker shock by quoted rates. In reality, the services offered by a firm like Liberty Tree Asset Management are often cheaper than the fees involved in leaving money in an old 401(k) (or in rolling retirement plans to a new employer plan as you change jobs). Of course, this is not true in every case. A skilled advisor should be able to help with a comparison of fees and should discuss what options are in your best interest.
While plan expenses are often the primary consideration, there are other factors to include in such a decision.
I can only speak for my company and what we offer, but I believe that the client receives a significant increase in service when working with us compared to what is offered by most 401(k) plans. Every employer-sponsored plan has someone that is hypothetically administering the investments, yet most plan participants have never met this person/firm.
In addition to providing service, as part of consolidating old retirement plans into a single IRA a Financial Advisor should be able to provide a cohesive investment strategy. Consider the opposite. For anyone with multiple old retirement plans, it becomes difficult to keep track of what each one is invested in. How can you be sure that these orphaned accounts are not allocated into funds that are pointed in completely different, counterproductive directions?
In an IRA, you also gain the flexibility to invest from a nearly endless world of funds. In remaining in a 401(k) plan, whether it is leaving the balance in an old plan or rolling funds to a new one—you are limited to the choice list of that plan. These funds tend to have “a few funds for everyone” and don’t provide the investment flexibility that open architecture can.
While there can be special cases, in general clients should have a single IRA which they roll qualified retirement plans to as they change jobs. The fees of this account should be transparent and should be equal-to-or-cheaper than the available alternatives. Finally, the investments should be allocated in a way that complements not only your goals and comfort with risk, but also the investments in your new retirement plan.
To grow assets over time, naturally fees should be kept low. Where fees are paid, some sort of service should be provided to justify the fee be it prompt customer service, active assistance with investments, cohesive financial planning beyond retirement accounts or, ideally, a combination of all of these. Fees for a service are one thing, but don’t fall into the trap of paying hidden fees to avoid the cost of a financial advisor.
Anthony (Tony) Sueck
Retirement Income Certified Professional (RICP)™