To Rollover Or Not To Rollover To An IRA, That Is The Question

by Silicon Valley Blogger on 2007-08-3118

Having worked at a total of ten jobs throughout the last couple of decades, I’ve happily collected some friends, fun workplace memories along with a few 401K accounts. What I can’t believe is that even after all these years, I’ve held on to these 401K accounts as if they were special souvenirs of each corporate experience that I’ve had, unwilling to let go of the puny amounts they hold, cherishing them like I was some kind of avid fund collector. In reality, it’s all just because of inertia and laziness. I keep telling myself that I really need to consolidate these accounts into one place so that I don’t have to remember all the web sites, passwords and pin numbers. I want to stop having to receive all the mail I’m getting from fund companies and just simplify them all. This has been my goal since the end of last year, when I vowed to consolidate my retirement accounts. Have I done it yet? Well of course not.

Then Charles Schwab sends me some information about what I should consider about rollover IRAs. Usually, we are encouraged to rollover our 401Ks to IRAs without a second thought, but in truth, there are both arguments for and against doing a rollover. Let’s review those reasons:

Pros and Cons of a Rollover IRA

Pros: Typical Reasons To Open A Rollover IRA

Why do it?

To consolidate your accounts.
Well, this is the primary reason I want to rollover to an IRA. I have mentioned that I’m not fond of having to keep track of all the material related to the legacy 401K accounts I have lying around. Half the time, I can’t even remember where they are and how much they have in it. I only know that for each particular account, I don’t have very much so I can’t get too excited about each individual one; but altogether, they should merge to become one nice meaty mega rollover IRA!

Rollover IRA 1

To get more investment flexibility.
The complaint I hear often from co-workers is that there just aren’t any cool investment choices in our 401K. The selections are limited. You’re probably stuck with what the company offers you as they try to cut costs by cutting down on the investment menu available to you. A rollover IRA at your favorite financial institution should give you everything under the sun to choose from! Also, if your 401Ks are like mine, then they could be governed by plan regulations that are not as flexible as those you would find in a rollover IRA that you control.

To gain more control over your accounts.
Nobody can abscond with your funds now that it is safe in your hands and you can keep your money wherever you so choose. Though in reality, you don’t have to worry if your ex-company collapses while your 401K is in stewardship with them. I also get annoyed whenever I hear that one of my previous companies gets swallowed up and bought out by some other company and now my 401K plan has to change. This has happened to me more than once where I had to deal with new fund mappings, some paperwork and sitting through new 401K plan walkthroughs with well-meaning specialists. So why not avoid this rigmarole with a rollover? Be your own money’s boss.

The IRA can be more efficient and thus, cheaper.
Since 401K/403(b)/employee sponsored plans are predetermined for employees, you don’t have any say on the quality of these funds or their other characteristics such as the types of fees they carry, the turnover they have, their size and so forth. They could have higher than normal fund fees that you have to live with. Bigger plans tend to have better economies of scale though such that fees are relatively lower for them.

Estate planning laws may benefit IRAs.
If you are to die owning 401K accounts, your money here would be subject to the beneficiary distribution guidelines that are specific to workplace retirement plans. These guidelines can be particularly restrictive, with your beneficiary receiving the balance in your account as a check, hence incurring a large tax obligation, or needing to keep the inherited account AS IS for a five year holding period. In 2007, your 401K plan may now allow you to specify a non-spouse as your beneficiary, who may then roll over your account in the case of your death, to something called an inherited IRA. Your heir would normally have much more flexibility dealing with IRAs, whose distribution guidelines are way more liberal. The tax and distribution rules here are exceedingly hairy for me to describe so I can leave you with some information from the Fool’s archives with An Inherited IRA and The New S-T-R-E-T-C-H IRA. The Stretch IRA seems like a seriously powerful repository for your assets.

Cons: Typical Reasons Why You Shouldn’t Roll Over To An IRA

401K to Rollover IRA
On the other hand, if you have already have an outstanding 401K plan, you may want to think twice before automatically rolling over your 401K to an IRA. Here’s why!

Unique investment options can exist that are only available through your employer.
Your company may provide you with options you can’t find elsewhere, such as no-fee investing in your own company stock at a discount, or allowing investing in previously closed funds. I’d mull it over heavily if I happened to work at Google!

If you will need to withdraw money before age 55.
You’ll incur a 10% early withdrawal penalty if you withdraw your money from an IRA before you reach 59 1/2, whereas some workplace retirement plans allow you to withdraw without penalty at an earlier age — at age 55. If you are thinking of living off of your retirement funds earlier than the designated 59 1/2 cut off, then you may want to keep your money in your other retirement funds for that flexibility. You can read yet more hairy details here.

If you want to convert your accounts to a Roth Rollover IRA designation in 2010.
For those of you considering a Roth Rollover IRA conversion in 2010, here’s a piece by Eric Cramer (CFP, CFA, financial consultant) which I found from the Charles Schwab Report (unfortunately, I can’t find the original copy at this time) that tells you how to time your roll over:

When you convert an IRA to a Roth IRA, the IRS says you have to look at ALL of your IRA money. So if you are rolling over your 401(k) it now becomes part of your IRA pool of assets. The big catch is if you have an IRA that has received non-deductible contributions — that portion won’t be taxable upon conversion to a Roth IRA. But if you dilute that “basis” with other contributions and earnings, then every dollar converted to a Roth will now cost more in taxes.

For instance, if you have a $30K IRA with $15K in non-deductible contributions, $5K in deductible contributions, and $10K on earnings from both sources, a conversion to a Roth IRA will only be taxed on the $5K in deductible contributions and $10K in earnings. But if you dump $70K from your 401(k) into the mix — and there were no after-tax contributions into that plan — then 85 cents of every dollar you convert to a Roth IRA will be taxable. It would be better to wait until after 2010 to rollover your plan.

To take advantage of lower minimum balance requirements.
Company retirement funds can set much lower balance requirements than regular institutions do. You may probably get away with very low amounts in your 401K while it may not be the case with IRAs.

To be able to borrow from your workplace retirement fund.
You may be able to borrow from your 401K or other workplace fund but not from an IRA. The catch is that this won’t apply any longer if you leave your company.

-ooOoo-

Given all that, I’m still determined to consolidate all the stuff I have. My scattered accounts have annoyed me for too long. There’s just something to be said about the freedom that you get from being able to make your own investment choices, and seeing that bigger balance residing in one place.

Copyright © 2007 The Digerati Life. All Rights Reserved.

{ 15 comments… read them below or add one }

Marco September 4, 2007 at 6:54 am

you should also mention 401ks are usually protected in case of a civil lawsuit while IRAs are not.

it shouldnt be your only criteria but it is a factor and one that most people are not aware of.

My Trader's Journal September 4, 2007 at 1:26 pm

To Marco’s point, an umbrella insurance policy should cover fears of a civil law suit. The benefits of rolling over a 401k outweigh the negatives to me.
I’ve rolled mine as I go from company to company. When my wife’s current job ends I plan to roll her past three 401Ks into one IRA too. I actively manage mine, but will leave hers in index funds/ETFs and keep the expenses low.

Silicon Valley Blogger September 4, 2007 at 11:41 pm

These are interesting points I was not aware of. Thanks for these opinions. If I were really on top of things, I would be rolling over my accounts right now. But unfortunately, procrastination has gotten the best of me. I still maintain that by the end of the year, I would make progress on the IRA consolidation and rollover task.

Pinyo October 25, 2007 at 8:18 am

My preference is to roll everything over so it’s easier to build a more effective investment portfolio. It also make your life simpler not having to look over so many little accounts.

Scott Brooks December 2, 2007 at 5:27 pm

The creditor protection you have with an IRA depends on the state that you live in. 401k’s and qualified plans have federal protection. IRA’s depend on the state.

Silicon Valley Blogger September 22, 2008 at 7:13 pm

Here’s where I begin some retirement account consolidation. I wanted to share a personal experience with selling shares in my 401K for the purposes of consolidating funds in a rollover IRA account.

I’ll make this admission now because I no longer work for the place, but my last job was at a bank. Because of having worked there, I had quite a bit of their stock in my 401k account which included purchases from my own contributions, matches from my employer and some bonuses I received over my term as an employee. It amounted to some five figures in fact, and was one of those few accounts I owned that had a concentration in one stock. My spouse and I don’t typically buy individual stocks, but we consider our employers’ stock as special cases.

Well, here is what this company’s stock looked like on Friday. And last Friday, I became a contrarian as the market did one of its dramatic reversals. After a 7% hike in one day, following a previously precipitous decline, I decided to sell off my entire position.

best places for your money when the stock market tanks

I made the sale not to time the market (yeah right ;) ) but for purposes of preparing for a rollover (and diversifying). Finally I’m getting around to doing it, and now’s a good chance to capitalize on the nice push up in price, at this stock’s all time high. I’m also not sure I’d like to be stuck owning a financial institution’s stock at the moment, given all the hullabaloo going on in this industry right now.

Oh and this morning, the stock is already down by 10.53%. Sure, it’s caught in your typical market roller coaster activity and temporary downdraft, but it’s still a relief to be off the ride for now.

What do you say….good move?

Erica Douglass September 23, 2008 at 5:20 am

Re selling your 401k funds: I think it’s a good move. Wells Fargo, as much as it would like to think, is not immune from the financial craziness. Sure, they sold off most of their subprime mortgage portfolio (with excellent timing), but they’re still holding on to tons of toxic “prime” mortgages which will begin to reset next year.

-Erica

theWild1 September 23, 2008 at 2:03 pm

That was definitely a great move even if the stock had gone up 10% the next day.

Silicon Valley Blogger September 23, 2008 at 5:11 pm

I usually keep my 401k very diversified, but I was swayed into over-concentrating in this stock by my former colleagues and co-workers at the bank. They were very enthusiastic about the company and were proud to have 100% of their funds in the stock.

This was last year. Seeing that much loyalty, enthusiasm and confidence in the stock from fellow employees of the bank made me join the bandwagon. You know — herd mentality and not wanting to be “left behind”, unable to ride the same trajectory towards potential profits. So I changed my 401k settings to go 100% into the stock as well.

I promptly forgot about this until this week, when my spouse mentioned that WFC was up 7% in one day. Being a passive investor (sometimes, too passive, in fact…), I hadn’t been checking up on my account for sometime (partly also due to not wanting to face losses up close).

Well, with all the market craziness of last week, I found that the 401k web site was sluggish, I lost my PIN and the phone lines to get to a 401k rep were jammed. Took me an hour to get my transactions in, but I’m glad that’s all over and done with for now.

RetiredAt47 September 24, 2008 at 4:23 am

It’s so hard to say what is good in this market, but I sold some bank stock on Friday (for a profit) as well. And you know what, it feels so darn good just to be out of it now, no matter what it does!

I read a great piece of financial/investment advice once: if you can’t sleep at night, you need to change your asset allocation until you can. I think of that phrase a lot these days!
:-)

Jon September 24, 2008 at 12:36 pm

I did the same sort of thing on Friday with my wife’s company stock for an old employer. I’d set a target price to sell it about six months ago, and when it came within a penny, I dumped it all. Some days market timing works out fine.

Dividend Growth Investor September 25, 2008 at 10:45 am

Wow a 5 figure amount in ESPP 401K, would be earning more than $4K/year in dividend income alone. But you are correct – diversification is important in order to ensure that your retirement nest egg would be somewhat protected.

George October 5, 2008 at 3:29 pm

I just bought Wells Fargo shares. Maybe I bought some of yours. I like the way your comment reminded me that when I buy a stock, I’m buying it from someone who is equally motivated to sell it. I think the best is yet to come for WFC.

Silicon Valley Blogger October 6, 2008 at 7:26 pm

@George,

That’s one way to look at it. I decided I would diversify my holdings in my rollover IRA as I’m not one to hold and monitor individual stocks. I’m pretty happy with my IRA’s diversified funds or index ETFs I guess. :)

David August 1, 2009 at 10:59 am

I am just starting to move my 10K out of savings where they are safe but not earning at all. It is good to see that being diversified is recommended as I would not want to put all my eggs in one basket. My new partner has lots over 30k so we are making sure we do not make the same mistake twice by becoming led by others or an emotionally led decision.

David

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