When people leave their jobs, one of the biggest decisions is what to do with their 401k? They're looking for help with one of life's major decisions. According to a recent GAO report, they aren't getting much.
Instead, according to the report, plan participants separating from their employers may be encouraged to choose rollovers to IRAs in lieu of options that could be more in their interest. Waiting periods to roll into a new employer plan, complex verification procedures to ensure savings are tax-qualified, wide divergences in plans' paperwork, and inefficient practices for processing rollovers make IRA rollovers an easier and faster choice, especially given that IRA providers often offer assistance to plan participants when they roll their savings into an IRA, concludes the report.
Then too, the GAO found that service providers' call center representatives encouraged rolling 401(k) plan savings into an IRA even with only minimal knowledge of a caller's financial situation. Participants may also interpret information about their plans' service providers' retail investment products contained in their plans' educational materials as suggestions to choose those products. Labor's current requirements do not sufficiently assist participants in understanding the financial interests that service providers may have in participants' distribution and investment decisions.
In addition to being subject to inefficient rollover processes and the marketing of IRAs, 401(k) plan participants separating from their employers may find it difficult to understand and compare all their distribution options, the report concludes. Information participants currently receive is either too generic and without detail, leaving participants without understanding of the key factors they need to know to make decisions about their savings, or too long and technical, leaving participants overwhelmed and confused. Labor regulations do not ensure that 401(k) plans provide complete and timely information to participants on all their distribution options.
For sure, putting your hard earn money in the best place is critical. Here's what to think about when debating what to do with your 401k.
Know your options
You must explore and understand the pros and cons of the various rollover options. Whether that be leaving the plan assets where they are, rolling over to a new employer plan, rolling to a self-directed IRA, or possibly converting to a Roth IRA.
To help you decide what your next steps should be, Jerome Golden, president of Golden Retirement, offers a few questions that you should ask yourself. “What stage of life am I in? Saving, transitioning to retirement, or about to retire? Will these savings be an important part of my retirement plan? Can the firm or advisor help me with creating that retirement plan to and through retirement? Am I looking for an account to aggregate current and future rollovers? Are the fund choices and fees competitive? Will I get help on fund selection and asset allocation?”
People sometimes misunderstand that as long as they more than $5,000 in assets, they can leave their funds in their previous employer's plan, says Dan Palmer, a certified financial planner for Rehmann Financial Group. In many cases, but not all, it can be advantageous to leave your funds in your current employer's plan, especially if it a large plan and the plan sponsor has done a good job of negotiating investment fees and overseeing investment options.
However, says Spencer Williams, CEO of The Retirement Clearinghouse, “Stranding your account with your past employer's plan complicates long-term planning and creates risks for those who lose track of their accounts.”
If you roll over your 401k to your new employer's plan, know that qualified plans typically have a limited offering of investment options available, but typically cover multiple asset classes, says Fenstad. Find what the new plan offers and whether you can enroll in it immediately or if you'll have to wait 6-12 months.
Self-directed IRAs open the choices to just about any available fund or security, he says. “For some, that flexibility is welcome, for others it becomes a sea of confusion,” he adds.
What you don't want to do is cash out. “It goes without saying that just withdrawing the funds (paying tax and possible penalties) is the last and least attractive distribution option,” says Keith Fenstad, certified financial planner with Tanglewood Wealth Management.
Handle the mechanics
Every retirement plan requires the completion of transfer paperwork. Some 401k plans will take the boiler plate transfer paperwork of the receiving institution (the institution who is receiving the rollover money), other plan administrators require their own specific transfer paperwork. You must contact your 401k plan administrator to find out before you submit the paperwork or it will hold up the process, warns Thomas Corley, president of Cerefice & Company. Some 401k plan administrators allow telephone authorization from the plan participant for the rollover. Telephone authorization is done after the new receiving account has been opened and is ready to receive the rollover funds.
Ideally, you want to facilitate the rollover via a direct transfer from the 401lk plan trustee to the receiving institution. If a check must be issued for some reason, you never want to receive a check made out in your name. The check should be made out in the name of the receiving institution. Why? If the check is made out in your name, yo have 60 days in which to get that money into the new account set up by the receiving institution. If you don't, says Corley, it will considered as a disqualified distribution and subject to income tax. If you are under age 59 ½, it will also be subject to a 10% penalty.
Ask tough questions
What are the costs and fees? “There is a difference in fees between a 401k and a brokerage IRA. With a brokerage account, you will be charged a brokerage or transaction fee on each trade. The GAO report mentions misleading information being promulgated that IRAs are free. Check out the costs involved with the financial institution,” says Kevin Cimring, joint-CEO of Jemstep, a money management firm.
For example, the share cost for mutual funds is more expensive inside an IRA rollover, says Lee Topley, managing director at United Trust. It's also important to understand how your financial advisor is being compensated for the money going into the IRA account. “If he is being compensated on revenue shares, it could alter how he chooses the share class,” says Topley.
What kind of flexibility will you have? “Who would go to for service on the account, say if you needed beneficiary changes? If you are retired and need income, what are your distribution options, monthly, quarterly, annual?” asks Fenstad.
While each option has advantages and disadvantages, there's no across-the-board right or wrong choice. Says Stuart Robertson, president of ShareBuilder 401k, “In the end, each person has to assess his or her specific situation and make the best personal choice.”