Roll Over Your 401(k) to an IRA and Take Control of Your Retirement Planning

With record unemployment rates, many employees are confronting the decision of how to handle the funds in their 401(k) plan when they leave their present employment.
For most employees, the choice is clear: they should take control of their retirement planning and roll it over. Here’s why:

1. Lousy investment choices. Most 401(k) plans are populated with high-cost, underperforming, actively managed funds (where the fund manager attempts to beat a designated benchmark). The system encourages the selection of these funds because brokers and insurance companies receive revenue-sharing payments from funds as the price of admission to the plan. Since low-cost index funds do not pay these fees, they are excluded, except for the token index fund that makes its way into the plan.
By rolling over your funds into an IRA, you can open an account with a low-cost fund family like Vanguard and invest in a globally diversified portfolio of low-cost index funds. You will reduce your costs and significantly improve your returns.
2. High fees. It’s almost impossible to compute the fees charged by 401(k) plans, and the securities industry likes it that way. One fact is clear: when you add them all up, they reduce your returns significantly. When you roll over your funds into an IRA, you can control these fees. Remember this: low fees correlate directly with higher returns.
3. Greater flexibility. Some 401(k) plans place restrictions on how money can be withdrawn. For example, they may require a retiree to withdraw on an “all or nothing” basis. You have total flexibility with your own IRA.
4. Easier compliance. IRA rules provide for required minimum distributions once you reach age 70½. If you have traditional IRAs, the calculation is based on the total amount in all of your IRAs. You can comply by taking money from any one of your IRA accounts. The required minimum distribution is calculated differently for 401(k) plans. It is based on the value of each 401(k) account, and the distribution must be taken from that account.
5. Estate-planning benefits. You can leave an IRA to a beneficiary and extend the tax-deferred benefits over the life span of the beneficiary. If the beneficiary is a newborn grandchild, the value of the deferral can be exponential. Leaving a 401(k) to a beneficiary is technically possible, but far more complex. The chance of your former employer failing to comply with one of the technical requirements for the transfer and triggering adverse tax consequences is meaningful.
The decision of whether or not to roll over your 401(k) into an IRA isn’t a no-brainer.
When it comes to creditors, 401(k)s provide better protection. The protection afforded by IRAs varies by state.
You may be able to avoid taking the required minimum distribution from your 401(k) even if you are over 70½ if you remain employed. You don’t have this wiggle room with IRAs.
If you decide to roll over your 401(k), be sure you follow all the rules for doing so. The funds must be transferred directly from the trustee of your 401(k) plan to the trustee of your new IRA. Otherwise, you can trigger adverse tax consequences.

Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read, The Smartest 401(k) Book You’ll Ever Read, and The Smartest Retirement Book You’ll Ever Read. . His latest book is Timeless Investment Advice.

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