#401K

5 Myths about 401(K) Rollovers: What’s the Rush?

5 myths about 401(K) rollovers: Should 401Ks (or 403bs, 457s, or TSPs) always be rolled over? Often, soon-to-be retirees are led to believe their impending retirement forces a deadline or urgency to “do something” about their retirement plan account. 

Several understandable myths surround the mystery of what actually happens to your money when leaving your employer. Below are five of them.

Myth 1: When you separate from your employer, you must take your retirement plan account (401K/403B/457/TSP) with you.

Actually very few employer plans require employees to leave the plan upon retirement. You have a choice to leave the account right where it is. 

This includes if you are widowed and your spouse was the employee. More than likely, you can stay with the retirement plan if you want to.

The rules for your employer can be verified by checking with your human resources department, or obtaining a copy of your plan’s complete document, usually available at your account’s website.

Myth 2: When you separate from your employer, it’s always best to take your retirement plan account with you.

Some people might not have the greatest level of fondness for their employer and want to sever ties with anything having to do with the company. While understandable, it’s important to separate facts from feelings about your money. 

Due to tighter ERISA and Department of Labor regulations, it’s very unwise for employers to have their employees’ retirement plan limited to only high-fee, high-risk, or self-serving fund options. Chances are that what’s available there is worth taking a more in-depth look.

On the question of where you are best served with your retirement funds, here is where you will get a wide range of answers. You can ask friends, family, the internet, co-workers, and even ChatGPT and go in circles.

Whether rolling over your retirement plan account is in your best interest depends on a few different factors. Keep reading to myths 3, 4, and 5 to find out more.

Myth 3: Retirement plan accounts have no impact on the ability to do a Roth conversion.

False. This particularly applies to people who have IRAs outside of their employer retirement plan. If you are considering converting part of an IRA you already own outside of a retirement plan to a Roth, the amount you can convert is subject to an arcane concept called the “pro-rata rule.” 

In general, under this rule, the amount you can convert is subject to a ratio that includes all IRAs, but does not include monies in employer retirement plans.

Therefore, if you roll over your retirement plan before doing a Roth conversion, you will likely limit the amount of outside IRAs you can convert. For many people retiring in their 60s and delaying Social Security, Roth conversion opportunities abound. It might very well make sense to wait to roll over at least until age 70 so that you can leave the Roth conversion option more open.

Conversely, if all of your retirement money is in the employer retirement plan and you are considering Roth conversions, then a total or partial rollover might make sense in order to then accomplish a “Back-Door Roth.”

If Roth conversions are something you are considering, it’s imperative to talk to a tax professional first before doing any rollovers, and before doing any Roth conversions.

Myth 4: Qualified Charitable Distributions (QCDs) can be made directly from a retirement plan account.

False. Qualified charitable distributions are distributions made directly from an IRA to a charity by anyone over age 70 1/2. They can only be made from IRAs, not employer retirement plans.

The reason to make a QCD is to reduce the taxability of IRA distributions. QCDs work very well for people over 70 1/2 who already have the intention and ability to give to charity, but are not able to itemize their charitable deductions.

If this is you, then you may indeed want to roll over your employer retirement plan account to an IRA so that you can accomplish QCDs from the rollover IRA. But if you’re a few years away from age 70 1/2, there’s no hurry.

Myth 5: Any investment options that you have in your retirement plan, you can also get in a rollover IRA or annuity.

False again. Some employer retirement plans offer institutional shares (often seen as “I” “R” “Y” or “Q” shares) of mutual funds, which have lower fees inside them. The minimum investment for many institutional shares is $1,000,000. Thus, the only way to access them for most retirement plan participants is to be in the plan, where your purchasing power is aggregated with other employees and retirees. Once you roll out of the plan, you may not have institutional shares available. Instead you might be limited to higher fee options common with the retail shares of funds.

Another type of fund only offered in employer retirement plans are stable value funds. Although not FDIC-insured, they are principal-guaranteed by an insurance company and generally pay a more competitive rate of interest. In some market environments a stable value fund makes a good substitute option for a short-term bond fund because it has the guaranteed principal and generally pays more than a money market fund (though not always). Nevertheless, by leaving the plan behind, this important option might be left behind, as well.

In short, rolling over your 401K is rarely a time-sensitive decision. Most people have enough going on already at a time of life transition. Take your time to talk to professionals who have no conflict of interest in advising you which way to go. For a decision this big, there’s no need to rush.

If you can relate to anything in this post and would like to talk more, we would love to listen. Schedule a call with Holly here: Contact.

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401K Decisions by Age Decade – 20s, 30s, 40s, 50s, 60s

How are 401K decisions affected in each age decade? Shortly after the 2008 financial crisis, I saved a Money magazine article on the topic of 401K investing, curious to see if I would change their advice two to three years later.  Now it’s over 10 years later, and most of that advice is still relevant. Following is a synopsis.  For the 20s, 30s, 40s, and 50s, not much has changed.  But for the 60s, note how the article leaned toward armageddon, contingency planning, and worst case scenarios.  There was nothing in the article about staying the course.  It’s interesting to reflect back on the mood at that time.

[The following are both direct quotes and paraphrasing of the main ideas of the article.  The sources listed are attributable to Money magazine.]

In Your 20s

In your 20s, the challenge is that retirement isn’t even on your radar. Debt is accumulating instead, and most 20-somethings can’t see past the goal of getting out of debt first.  According to the Project on Student Debt, 2007 graduates on average who took out student loans left college owing $20,000.  Nevertheless, 20-somethings should pay off high-interest debt like credit card bills and start funding a 401(K).

Nearly half of all twenty-somethings with a 401(k) plan turn down the company match by not contributing the full qualifying amount – essentially free, tax-deferred money.

What can you do? Start brown-bagging lunch. For someone making $30,000 a year, setting aside $35 a week is all it takes to sock away 6% of salary.

An additional pitfall at this stage is job-hopping. When switching employers, many are tempted to pull out their 401(k) savings. But, while $5,000 may not seem like a whole lot of money, if invested, that amount will be substantial by the time you retire.

In Your 30s

By this decade, just being enrolled in the retirement plan isn’t enough. How the money is invested begins to take on more importance. According to a survey by investment advisor Financial Engines, 40% of all 401(k) participants make investing mistakes that impede their portfolios’ growth.  The two most common mistakes are: 1)  investing too conservatively in cash, therefore not beating inflation; 2) investing too narrowly in a single stock (typically, the employer’s).

To catch up, learn to diversify according to “asset allocation.” Embrace both stocks and bonds. Combining the two will bring a cushion against market drops.

If your 401(k) has a Roth feature, and you believe your income taxes will be higher in retirement, use that feature to invest after-tax dollars now for tax-free withdrawals later.

Once you have your portfolio fine-tuned, revisit it on a regular basis but no more frequently than quarterly to “rebalance” to your original mix. If you start managing your investments early,  you can reap rewards down the line.

In Your 40s

Too many claims on the paycheck becomes a common problem for forty-somethings. Even though you are entering your peak earning years, major expenses like college tuition loom. When the AARP recently asked workers why they didn’t save more for retirement, 33% of 45-to-49 year olds said they were saving for a child’s education instead.

Only 10% of 401(k) participants in their 40s are saving the full amount allowed under the pretax IRS or plan ceiling, and that’s the highest proportion of all age groups. Now is the time to max out your contributions to $16,500.

What about the kids? As Fidelity’s Mike Doshier says, “You can get student loans, you can get car loans, but you can’t get retirement loans.” Don’t dip into your 401(k) for tuition expenses. Save as much as you can, ideally, 10% of your income.

In Your 50s

When the stock market falls at this age, your nest egg begins to look cracked.  The market will probably rebound before you retire, but how do you make sure you’re protected against another downturn?

Seemingly seasoned investors still make rookie mistakes. Given the option, 40% of 401(k) participants in their 50s keep more than 20% of their savings in unrestricted company stock, a perilously risky proposition, no matter how healthy your employer is, especially for those nearing retirement.

50-somethings are allowed to make catchup contributions. You can put an additional $5,500 in your 401(k) every year. Fewer than 20% of eligible participants take advantage of that option, according to Vanguard.

In case the stock market takes a dive just in the year you want to retire, that is the time to create a cash cushion by shifting 5% to 10% of your balance into short-term bonds or cash, generally two years ahead of time. In the decade before retirement, it’s more important than ever to make sure you’re controlling for risk and positioning your portfolio to ride out rough patches.

In Your 60s

In a down market, the dilemma facing the ready-to-retire set is:  retire later or retire on less? When savings shrink drastically late in the game, prepare to adjust your expectations and your game plan.

More than half of workers over 60 say they will probably postpone retirement, according to an AARP survey. 68% of fifty-somethings and 70% of forty-somethings said they were likely to work longer than they had planned due to the 2008 market meltdown.

If you can stay on the job, working a few extra years can vastly improve your long-term financial prospects. You can cover expenses, add to savings, and give your portfolio time to rebound.

Your pre-2008 expectations are gone, so if you’ve already retired, rethink your budget. Look for ways to postpone withdrawals, or consider starting Social Security early. You’re eligible at age 62. Finally, plan for longevity and inflation. That means keeping a portion of your portfolio in equities even after retirement.

Notice the doom and gloom tone from that time? For the 60-somethings who did not panic and sell out their 401K balances during those difficult times, there may have been a sigh of relief. Yet, remember life expectancies are lengthening. Money market returns won’t help the money last into our 80s and 90s.  Although once-in-a-lifetime market plunges are difficult to stomach, some percentage in a diversified stock portfolio is likely necessary to maintain your lifestyle for decades to come.

For more on how to preserve your lifestyle post-retirement, see the The Mindful Money Mentality: How To Find Balance in Your Financial Future.

Continue Reading401K Decisions by Age Decade – 20s, 30s, 40s, 50s, 60s