Drill Down: Should You Keep Your 401k with Your Old Employer?

Keeping your 401k with your old employer is usually not a bad choice, though it’s often not the very best. However, if you have a lot of other things on your mind while you are changing jobs, don’t worry about leaving the 401k behind. You can move it later without any hassle. There is a good reason to move your 401k away from your old employer, but to understand it properly we need to learn some history. In the old days, like way back in the 1980s, companies set up 401k plans to keep their employees happy. Workers with 401k accounts change jobs less often, thereby saving the company money on recruiting and training costs of new employees. And you thought they loved you for your personality!

When these plans were originally formed, the company paid for the plan’s administration. That is, they paid some other company to keep track of how much each employee contributed, how much each person had accumulated in the plan, and to handle disbursements and rollovers. The cost of the administration isn’t huge, but it is an expense.

At the same time, different mutual fund management companies were trying to get the business of managing 401k investments. The various mutual fund companies would make the rounds to corporations saying, “Use me to manage your 401k funds, not him.”

Then one smart fund company got an idea: charge higher-than-average fees on their mutual funds and offer to cover the 401k administration costs. Making sales calls to corporations with 401k plans, their sales pitch is, “Use us and we will pay the administrative costs, saving you all of the money you are currently paying to administer your 401k plan.” The catch here is that the mutual fund companies could only afford to make that offer because they were charging higher fees to manage the mutual funds in the plan. Who ended up paying this higher cost? I bet you figured it out. No longer was the employer bearing the cost of administration—the costs were passed on to the employees through the higher mutual fund fees.

It’s possible that your old 401k plan is an old-fashioned plan where the employer pays to administer the thing—possible but unlikely. What is more likely is that you are paying above average fees to the mutual fund management company so that your poor old employer won’t have to pay. That was fine back when you worked there because the advantages of the 401k were great enough that you could absorb the higher fees. Now that you have left that employer, though, you are free—free to be cheap.

By rolling your 401k over into an IRA, you can get out from under the higher fees that your old plan probably paid to the mutual fund managers. That is why I recommend that you don’t leave your money at your old employer.

That stated, let’s keep this advice in perspective. Having some money set aside for retirement is very, very good. Getting the very best deal possible on managing the money is good, but it’s a relatively small issue.

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Drill Down: Should You Move Your Old 401k to Your New Employer?

Moving your old 401k to your new employer’s 401k plan is a reasonable thing to do, but not my first choice. Keep in mind, however, that not all employers allow plan-to-plan rollovers. The old employer has no say in the matter; if you want to move the 401k, you can. But the new employer may or may not allow rollovers. So if you’re inclined this way, check out with your new company what its rules are.

The advantage of the rollover to another 401k is that all of your money is together in one place. It’s not that the money gets lonely if it is separated from its cousins. The benefit of the rollover is that you only have one account to think about. You can make all of your asset allocation decisions inside one account. When you retire, you will be able to draw money from a single plan rather than from multiple plans. This constitutes a small convenience. If you have a busy, hectic life, I understand your desire to keep things simple.

The downside of the rollover into a new 401k plan begins with its cost. If you skipped the section on keeping your 401k in the old plan, read it now. It explains that the cost of the mutual funds in your 401k plan is likely to be higher than the best deals you can find in mutual funds for an IRA. For that reason, I like rolling over into IRAs better than anything else. But it’s not hugely wrong to roll over into a new 401k plan, just not my preferred choice.

Before rolling your old 401k plan into a new one, check out two things about the new plan. First, make certain that it has enough choices for you to allocate your assets the way you want to. If not, I can guarantee that a good IRA offers all the choices you could possibly need—and more.

Second, check the fees on the mutual funds in your new 401k. If they are running more than one percent of the fund’s assets, you can do better in an IRA. (Don’t worry if the foreign funds cost more than one percent; they are more expensive to operate.) If your funds are costing more than 1.50 percent, then definitely do not roll over into a new 401k. Instead, go into an IRA. Reread the discussion of fees in the investment chapter.

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Drill Down: Should You Roll Over Your 401k into an IRA?

I like this choice. Let’s begin with why, and then I’ll explain the mechanics. The best thing about the IRA is that you get to make the choices yourself. That’s a little scary for some people, but with the help of this book, decisions are a snap.

Chapter 8, about Death and Divorce, presents another reason to roll over the 401k into an IRA. If you die, the rules about how your heirs receive the money in your 401k are set by your employer in the 401k plan documents. They may not be as generous as the IRS allows, because the employer often wants to save on administrative expenses. If your 401k is rolled over into an IRA, your heirs will have the full advantage of the minimum distribution schedules set by the IRS. You can set up your IRA at any one of the hundreds of companies that manage funds. Banks can handle the job, but for most people, going directly to a company that manages mutual funds will work out best. If you have a stock broker or financial planner that you like working with, you can set up the IRA at that person’s company. However, don’t feel obligated to use the broker or planner for your IRA.

If you have it in your mind to buy individual stocks, you can set up your IRA at a stock brokerage firm. You could use an old-line company like Merrill Lynch, or a discount broker like Charles Schwab.

If you simply want to follow the guidelines of this book, your answer is easy. Pick a good mutual fund family and open your account there. Mutual fund families include the low-cost families such as Vanguard and Fidelity, and more traditional families such as American Funds and T. Rowe Price.

Here are the steps involved in picking a mutual fund family.

1. Determine if the fund family has the range of funds that you need. Review my advice on asset allocation. In general, you’ll need access to domestic (United States) stock funds, including large and small cap funds; foreign funds, ideally both developed and emerging countries; and a bond fund. All of the large fund families will be able to handle your needs. The only time that you might have a problem is if you are considering using a small, new fund family.

2. Look at fees. I confess. I’m cheap. I like fund families such as Vanguard and TIAA/CREF because they have very low fees. Higher fees don’t always result in better performance.

3. Get good customer service. This is a competitive market. You should be able to get very good customer service. If your experience is lousy when you are setting up your account, it WILL NOT GET BETTER after you open the account. Companies almost always treat prospective customers better than existing customers, so if your experience is not great while they are trying to sell to you, it certainly will not improve after you sign on the bottom line. The bright side is that you can change to another company if you’re unhappy. This is a short-term arrangement, not a marriage for life.

These choices show the advantages of the IRA rollover. You can make sure that you get exactly the types of mutual funds that you want. You can make sure you are selecting a company with great customer service. And you can get the right funds with great service at a very low price. That’s the beauty of the IRA rollover.

Bill Says: Set up an IRA and move your 401k over when you change jobs. Next time you change jobs, use the same old IRA and roll your 401k over again.

If you roll your 401k into an IRA that has no other contributions in it, you preserve the possibility of later rolling the IRA into a new employer’s 401k plan. I don’t see a lot of value to having your money at a 401k rather than an IRA—usually you have much more flexibility within an IRA. However, it’s easy enough to preserve your flexibility by setting up a separate IRA just for your rollover.

It is VERY important to get the details right in a rollover to an IRA. Do it wrong and you owe taxes right away. Here are the steps involved:

1. Select a company to administer your IRA. Tell them you will be rolling over a 401k plan, and ask for detailed instructions on how the check to them should be made out.

2. Tell your 401k administrator that you want to roll over into an IRA. Provide them with information about your new IRA account, including the name and address of the IRA administrator, and your account number. Specify that this is a “direct rollover,” also known as a “trustee-to-trustee” rollover.

3. The 401k administrator will make out a check to your IRA account. If you have a cool 401k administrator, they will send the check directly to your IRA administrator. If you have an old-fashioned administrator, they will send the check to you.

4. If you receive a check, inspect it carefully. It should be addressed in some fashion that resembles this: “XYZ Funds Inc. for benefit of John Doe.” There are a lot of variations on this, but the key is that the money is headed over to an IRA company. You have a problem if the check is made out to you: “John Doe.”

5. If you receive a check that looks good, send it to your IRA company; be sure to include your name, address, and account number.

6. If the check looks wrong, stop. Do not deposit it to your account. Call for help. Ask the 401k administrator if this is how the check is supposed to be made out for a direct rollover. Ask the IRA administrator if the check looks right for a direct rollover. Never, ever, deposit the check in your personal bank account. If you get an OK from the IRA administrator, send the check to them.

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