A few months ago, I initiated the process to roll over my pension to an IRA at Vanguard. Leaving my job early, but after having worked at the company long enough to be vested in my pension, I chose to receive a lump sum of my accrued pension, about $18,000, rather a lifetime annuity of $65 per month. The transfer was finalized this week after a long delay. It’s time to turn my attention to my 401(k).
It often makes sense to roll over a 401(k) when you leave a job. I’m considering a 401(k) rollover to a discount brokerage to alleviate some of the problems I have with my former employer’s retirement plan. These problems are common among employer plans, even those managed by the same discount brokerages you’d likely consider to receive a rollover.
- Management fees. Most employers’ 401(k) plans have expensive management fees. One third of the investment options in my company’s 401(k) have expense ratios over 1%. I am choosing Vanguard for comparison because most of my other investments are held there and the management fees are low. My 401(k) balance right now is a little above $100,000, so a difference of 50 basis points in an S&P 500 index fund is worth $500 a year. I normally wouldn’t throw $500 out the window.
- Investment options. In my employer’s plan, I’m limited to 15 investments. That may be a larger number than what many other employers offer, but it’s a drop in the bucket compared to what I’d have access to if I move the 401(k) elsewhere. A brokerage can provide investment opportunities in the form of stocks, bonds, mutual funds, ETFs, metals, real estate, and more. All of these can be part of your IRA, in many cases allowing you to defer tax on your gains until you start receiving your distributions. My choice, though, is Vanguard, where I would choose to invest only in Vanguard’s mutual funds. Even this option provides more flexibility than leaving the funds in my former employer’s retirement plan.
Once you decide that you don’t want to keep your 401(k) at a former employer, you will need to decide the destination of those funds. These are the typical options:
- A brokerage, providing the most investment choices.
- A mutual fund company, like Vanguard, offering limited but low-cost choices.
- Your new employer’s retirement plan, possibly offering limited and expensive investment choices.
- Your bank account, possibly triggering income tax and penalties.
For the first three options, you can limit yourself to as small an amount of trouble as possible — rollovers seem to involve at least a minimum of some trouble — by initiating a direct rollover. This way, the funds are sent directly to the new retirement plan provider. There’s no risk of you accidentally keeping some of the funds. The fourth option should be considered only as a last resort. If the funds are designated for retirement you might as well leave them in an account that you can’t touch, avoiding extra expenses.
When you are considering a rollover, keep in mind the form of your funds in your 401(k). For example, some of my retirement funds at my former employer are in a Roth 401(k). When I move these investments to Vanguard, I will need to handle the rollover separately to ensure they end up in a Roth IRA. If you have an after-tax 401(k), these funds will need special consideration, as well. Some brokers and mutual fund companies won’t accept Roth or after-tax rollovers, so verify your chosen recipient can handle your entire 401(k) before you initiate any changes. I’ve found it helpful to speak with a representative at the company who can review your entire 401(k) to increase your confidence that you’re choosing the correct retirement plan options.
The last consideration should be whether your new asset allocation, after the rollover, should match your old asset allocation. My current allocation is a bit of a mess:
|Large Cap Growth
|Large Cap Value
|Mid Cap Growth
|Mid Cap Value
I could choose either to invest similar amounts in funds that roughly match this investment mix or just put everything into the total stock market index fund. This is the my current dilemma, and I’d want to decide what to do before initiating the rollover. It won’t hurt you in terms of taxes to transfer money from one fund to another within your 401(k), so take this opportunity to rebalance your portfolio.
These are the steps I plan to follow once I’m ready to begin:
1. Contact the recipient. In my case, Vanguard. I can either create a new account or roll over my 401(k) into an existing traditional IRA and an existing Roth IRA. I’ll need to make Vanguard aware that my former employer will be sending a check. In some cases, you can initiate an asset transfer. Regardless of the type of transfer, the recipient will offer instructions for sending the funds.
2. Instruct the former employer’s plan management. You may need to complete forms to be mailed in or you might have the option to submit your transfer request online. You’ll need the information provided by the recipient to avoid having a check sent directly to you.
3. Choose your new investments. Remember to look at your entire collection of assets when determining your optimal asset allocation. Your investments should also match the amount of risk you’re comfortable with.
4. Verify your transfer is complete. Although I initiated my pension rollover in February, it wasn’t complete until the end of April. The process was long, but both companies completed the process as they agreed. I expect the process of rolling over my 401(k) will be somewhat faster.