Know your choices when it comes to 401 (k) distributions.
A recent survey by Financial Engines1 found that 52 percent of workers between the age of 35 and 65 have left a job where they had money in the employer’s 401(k) plan. You may assume that you should take the money with you when you leave, but is that really your best option?
You might be retiring, or leaving to focus on family matters, or simply moving on to a new opportunity. Regardless, you will need to decide what to do with the money you have accumulated in your workplace retirement account. When the time comes, you have several choices.
Leave your money where it is
Doing nothing is always an option, and in this case, it may be the best one you have. Surprisingly, 42 percent of survey respondents didn’t know it was even possible. The greatest benefit of remaining in a former employer’s plan is having access to the institutional buying power and high-quality plan design that many leading employers have made available. The result: potentially lower fees and higher quality investment options.
In some cases, remaining in a former employer’s 401(k) plan may not be the best choice. For example, if you change jobs frequently you might wind up with multiple accounts that can make retirement planning more difficult. In this case, you might consider consolidating your accounts into your current employer’s plan. Regardless, it helps to speak with an independent financial advisor to get an unbiased opinion.
Do a rollover to an IRA
Many advisors will tell you that your best choice is to rollover or transfer your 401(k) money into an IRA. When a salesperson tells you this you need to ask one question; What’s in it for them? Most 401(k) plans do not charge a separate fee for transactions within the account. But an IRA set up with a brokerage firm may charge commissions for each transaction you make or an investment advisor where you pay and annual fee on the account value. It is also important to understand any other fees you may be charged to maintain the account. This is especially true if you are considering a rollover to a variable annuity, where high fees, lock-up periods and surrender charges can limit the availability of your funds and seriously eat into your savings.
You should also consider how you will manage your new IRA. If you are comfortable making investment decisions on your own, you might benefit from the expanded investment options available to you in a separate IRA account. But keep in mind that unlike a 401(k), IRA accounts are not covered by the Employee Retirement Income Security Act. This leaves brokers free to recommend investments that may not necessarily be in the best interest of the investor. And since many workers may not fully understand the nature of these transaction, they may end up with investments or accounts that are not in their best interest.
Withdraw the money
This is probably your worst choice. Unless you are facing severe financial stress, your 401(k) money should be used for one purpose only – your retirement. Withdrawals of pre-tax contributions, employer matching contributions and any earnings will be taxable as ordinary income. And if you are under age 59½, a 10 percent IRS penalty may apply as well.2 The Financial Engines survey found that more than 28 percent of retirement investors were not aware that they could incur such tax costs and penalties.
In some instances, you may avoid taxes and penalties if the money is deposited into a new qualified account within 60 days. This is referred to as a rollover. If you have the choice, you should opt instead for a direct transfer of funds instead of receiving a check. This avoids any possible errors, back-up withholding, or potential for incurring taxes and penalties
A Side-by-Side Comparison
If you are considering an IRA rollover or transfer, you should consider these factors:
- The investment options available for diversification
- Any costs and account-related fees and expenses
- The level of service available
- The availability for penalty-free withdrawals between ages 55 and 59 ½.
- Whether the account offers legal protection from creditors under federal law.
- The amount of the required minimum distribution (RMD) once you reach age 70 ½.
- Any factors relating to employer stock.
- Any state tax considerations.
Financial Engines research revealed that plan participants in employer plans that have adopted Financial Engines services, on average, have access to funds with fees that are below the industry average3. Comparing in-plan fees versus the industry averages, participants who keep their 401(k) savings in the workplace retirement plan, rather than rolling out to retail products, can potentially increase their retirement savings by 4.7 percent after 10 years on a $100,000 initial balance. This represents additional savings of more than $4,600 for the employee to potentially live on in retirement4.
Unbiased Advice Can Help Employees Make the Right Decisions
Every worker’s situation is different and with a range of distribution options available, how can you know which choice is best for you? One approach is to get unbiased professional guidance from an independent financial advisor. Nearly 80 percent of respondents to the Financial Engines survey believed it is important to get financial advice from an advisor who is a fiduciary. That is, an advisor who is required to put your interests above their own. However, 69 percent also said they had never consulted a financial professional about their retirement distribution strategies. That may be a missed opportunity, especially when nearly 80 percent of those who did consult a financial advisor said they felt more confident about their distribution strategy.
1. Reconsidering the 401(k) Rollover, Financial Engines, June 2019
3 ICI Research Perspective, Trends in the Expenses and Fees of Funds, March 2019
4 Savings on $100,000 with a 5% compound growth rate over 10 years; analyzed fees for 60/40 equity/bond portfolios and found a 0.31% differential in underlying fund fees when comparing in-plan fees at plan sponsors offering Financial Engines’ services vs industry averages; based upon Edelman
Financial Engines data as of 5/31/19 and ICI 2018 industry average.
This material was prepared for informational and/or educational purposes only. Neither Financial Engines Advisors L.L.C (also referred to as Edelman Financial Engines) nor its affiliates offer tax or legal advice. Be sure to consult with a qualified tax or legal professional regarding the best options for your particular circumstances.