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Should I roll over my 401(K)?

Should I roll over my 401(K)? Good question. While there may be reason not to do so, in most cases, you would be better off if you did. Here’s how to decide if you should, and where you should roll it over to.

Rolling over your 401(K) helps you keep all your retirement money in one place and can offer you additional control. In some cases, it also saves you money.

When you might not want to roll over your 401(K)

Should I roll over my 401K?

As you can see from this partial statement, in 2013 I paid CSC $38 to work for someone else. That was nearly 1% of my earnings. I should have rolled over that 401(K) as soon as I left the company.

If you only have one 401(K) account besides the one you have now, and that 401(K) plan doesn’t charge you fees to manage the account now that you’re a former employee, you can get by with leaving the money there. I’ve left old 401(K) accounts in place under those circumstances myself.

It’s not a slam dunk, so I’d rather you not quit reading just yet. But if it’s not costing you money to leave it where it is, you’ve lost the biggest reason to roll over. The only remaining reasons are for convenience and flexibility, but those are definitely secondary. If you do decide to leave your 401(K) where it is, make sure you’re not paying fees for the convenience. They make the percentages sound like they aren’t a lot, but over time it is. If you’re going to pay management fees, pay management fees for someone who’s working for you and looking out for you, not for your former employer.

Should I roll over my 401(K) to my new employer?

Your new employer’s 401(K) may offer the option to roll your old 401(K) account or accounts into the new one. They’ll make it as easy for you as they can. Usually they’ll set up a conference call with your old plan administrator and do all the talking after you give permission. It takes a few minutes but it’s a lot less painful than it sounds.

This can be super convenient, since all your money is back in one place. That means you can set up your retirement goals in one place, not two, and you won’t run into a problem with an old plan behaving as if you’re forever 29 years old. It also gets you out of paying those management fees. There’s a bit of a fee structure built into the investments themselves, so you don’t want to be paying management fees on top of them unless you’re getting something very tangible in return.

But there can be a downside to rolling your 401(K) to your new employer. Company 401(K) plans don’t have a lot of flexibility. They may offer a few fund choices but they’re really designed for people to set their expected retirement year and let the management company decide the best way to invest for you. If you’re fine with telling a your 401K that you intend to retire in 2045, so use the Target 2045 profile, this could be the way to go for you. And I’m not going to tell you that approach is wrong. If you contribute every year to a plan and either start early enough or contribute aggressively enough, you’ll do just fine with this approach.

But if you like more control, including the mother of all tax options, there’s another option.

Should I roll over my 401(K) to my own rollover plan?

You can open your own 401(K) rollover plan wherever you want. You can go with a discount administrator like Fidelity or Vanguard that offer tons of flexibility and even their own low-overhead mutual funds to invest in. Or you can go with a firm like Edward Jones, who offer a very hands-on, full service approach who take care of everything for you–for a small fee, of course. Or if you have a high enough balance, you can get in the door with someone more exclusive.

And if you look hard enough, you can probably find something in between, too.

Self service vs full service

I started investing when I was a teenager, so I’m fine with taking a build-it-myself approach. I pick a mix of index funds appropriate for my age, rebalance a few times a year, and don’t look at it the rest of the time. The fees on index funds are very low, so I get a lot of value for my money with this approach. And when using index funds, there is no reason to be afraid of stocks.

But you don’t have to limit yourself to index funds. With your own rollover 401(K) plan, you can invest in any kind of mutual fund you want. Or individual stocks, or various other investments. You can be as aggressive or as safe as you want.

Of course you can get a full service approach by just using your current employer’s 401(K) plan too. The question is whether you prefer to meet with someone in their office once or twice a year to talk about finances in general. Whether the adviser you get can outperform your employer’s 401(K) plan is a coin toss. But that adviser can help you with other financial planning, including saving for college and making sure you have enough life insurance.

But there’s one other reason you may want to roll over into your own plan. The ultimate in tax flexibility.

The #1 reason you might want to roll over into your own 401(K)

The major reason for rolling into your own 401(K) is the ability to convert a traditional 401(K) into a Roth 401(K). I go over the differences between the two here, but the major difference is that you owe no taxes on the earnings in a Roth 401(K). The catch is you have to pay taxes when you convert it.

What some people do is work out with their accountant just how much margin they have in their current tax bracket, then convert that amount from a traditional 401(K) to a Roth 401(K) that year.

The tax burden to do this is considerable, but so are the savings. This is a move you won’t want to make without professional advice. But it’s an option that’s probably not available with your employer 401(K), so if this is something you would even consider, you probably want to get your own rollover 401(K) instead, to leave your options open.

One more thing: A word about investment types

One reason people may prefer to roll over into their own 401(K) is to get more investment types available to them. This option is attractive to people on both extremes. Hands-on investors like being able to pick and choose investments according to their whims and move between them at any point in time.

People who don’t understand stocks and bonds and are afraid of them like being able to choose “safe” investments.

There’s danger in both of these extremes as well. My dad was a very hands-on investor and did very well, until someone talked him into a penny stock scheme. He never told anyone how much he lost in the scheme, but he only said it was a lot.

The danger with “safe” investments is that while the risk of losing money may be low or non-existent, the rate of return is also very low. If the rate of return doesn’t keep up with inflation, you’re in danger of not having enough for retirement.

Worst-case scenarios

I recommend learning enough about stocks and bonds to get over your fear of them. If you’d invested your life savings in the S&P 500 in September 1929, the month before the crash that started the Great Depression, but held the stock, by the end of 1945 you would have made your money back.

Looking at more recent history, what if you’d done it just before the housing crash? If you’d made the same investment in October 2007 and held your stock, you would have made your money back by October 2012.

Both of these cases assume you made no further investments after the market crash. If you invest on a recurring basis every pay period and spread your holdings out over several classes of investments, your losses will be lower, and your recovery time will be faster.

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