Posted on 03 September 2008
By Mark Miller
“Should I stay or should I go?”
I’m fairly sure The Clash wasn’t thinking about 401k accounts when they wrote that English punk rock classic. But it’s a good song to sing whenever you leave a job and need to decide where to park your fund balance.
Many people naturally lean toward taking their 401(k) money with them when they change jobs or retire. And rolling your fund balance into a new employer’s plan can make sense if you’re concerned about keeping your funds consolidated in one place.
But if you’re retiring, your choice is to leave the money with your former employer’s plan or roll your fund balance into an individual IRA. There can be good reasons to leave your employer’s plan–but in many cases it’s not your best move. You’ll be shouldering higher expenses in an individual IRA than in the employer plan, which benefits from the institutional pricing made available due to the volume of buying and selling that it does.
Big dollars are at stake here. In 2006, $195 billion was transferred from private defined benefit plans to IRAs, according to Alison Borland, who heads the defined contribution practice at Hewitt Associates, the big employee benefits consulting firm.
Mutual fund companies are going after this huge market with rollover ad campaigns that often boast about IRAs with no front-end loads or commissions. But higher expense ratios still are embedded in the cost of the funds’ investments. Fund expenses are never a sexy topic of discussion but they can make a huge difference in your returns over time.
Hewitt did some research comparing retail IRAs and company 401(k) plan returns, which Borland testified about at a July hearing convened by the U.S. Senate Special Committee on Aging.
The results–displayed in the chart above–were startling. Hewitt ran a scenario in which an employee leaves a company at age 35 with an accumulated balance of $101,808. The hypothetical saver was an active saver who put away eight percent of pay annually for 10 years, and also received a typical employer matching contribution.
If this employee rolls her account into an individual IRA, she would have $1,130,450 at age 70, when she’s required to begin taking distributions. Had she left that money in her former employer’s plan, she’d have $1,246,700, or $116,250 more at age 70–and that’s if the employer’s plan has expenses that are average for the industry. If the employer plan was very large and more cost-efficient, she’d have $244,078 more at age 70 than if she’d rolled the funds into an IRA.
When you’re getting ready to retire, your employer may not be your best source of advice on the rollover question. Borland says employer attitudes differ on managing the funds of former employees.
“Employers aren’t obligated to provide guidance on this,” she says. “And some employers prefer that employees take the money with them because they don’t want to shoulder the additional administrative cost, or the perception that they face higher fiduciary risk of complaints or lawsuits from former employees.”
Other employers, she says, like to keep former workers in the plan. “It helps the employer’s purchasing power when they keep more money in the plan. If they care about their employees and want to do the right thing, they are happy to keep former employees in the plan.”
If you are considering a rollover, Borland advises asking the fund vendor about ongoing expenses and fees for the funds you’re considering. You want to know the total expense ratio, which is overall expense expressed as a percentage of average net assets over a specific time period.
Then, assess your situation at your employer’s plan. Will you have sufficient access to your investments after you leave, and do the plan’s investments meet your needs?
Also consider what kind of guidance and advice you’ll be getting in different scenarios. Some workplace 401(k) plans include assistance with investments, while others are do-it-yourself. Advice could also be limited if you’re moving to an IRA plan, but if you plan to use a financial adviser in retirement or invest in a managed fund, there could be good reasons to roll your balance out of your former workplace.
What to do if you’re not sure how to proceed as you’re walking out the door at your old job? Borland advises a cautious approach. “The good news is that if you leave your money in an employer’s plan you can always roll it over later. So be conservative and don’t rush to make a decision.”