For lots of good reasons, you’ve left a trail of company retirement accounts in your wake as you’ve climbed the career ladder. We know: You may have been busy. And there are certainly more fun things to think about than retirement, which seemed so far in the future.
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But now all those orphaned accounts could be holding you back. If part of your retirement money is stuck in a 401(k) with only a few good investment choices, or a forgotten individual retirement account with high fees—you could be losing money. Over a career, and a string of job changes, those mistakes can add up to thousands of lost dollars.
Plus, having multiple retirement accounts can make it harder to know what investments you hold. For instance, people who own more than one type of retirement account are more likely to invest in a higher percentage of stocks than those who don’t, according to a recent study by the Employee Benefit Research Institute. And that might not be the best mix for you at this stage in your investing life.
“With multiple accounts, it can be difficult for clients to get a true sense of whether they’re properly allocated and taking an appropriate amount of risk,” says Brandie Farnam, a LearnVest Planning Services certified financial planner™.
Luckily, one of the quickest ways to regain perspective on your retirement is rolling over those balances into fewer accounts, which could include an IRA, a former employer’s retirement plan or your current employer’s plan.
The bottom line: Not knowing the consequences of your rollover choices can cost you money. And nobody’s going to roll over your accounts for you. That’s why we’ll take you through your choices to tell you everything you need to know to gain more control over your nest egg.
Why Consolidation Is Key
What to do with a retirement account usually comes down to three main choices—leaving your account with a former employer, transferring an old retirement account to your current employer’s plan or rolling over your balance into an IRA.
There is a fourth choice, but it usually doesn’t make a lot of sense unless you’re retirement age: You could cash out, but that would trigger taxes and penalties. If you withdraw funds from a retirement account before the age of 59 ½, you’ll pay a 10% early withdrawal penalty and money will be taxed as regular income. If you cash out, not only will your money stop growing, but you’ll end up with less money after paying all of the taxes and fees.
Regardless of what you do, you should probably aim to consolidate your money in a couple of accounts. “Consolidation offers a big benefit,” says Bob Hilton, a financial adviser with Raymond James in St. Petersburg, Fla. “The more accounts you have spread out, the more complicated they are to manage, and most folks tend not to do a very good job.”
Option 1: Leaving Your Account With an Old Employer
Letting your balance ride in an old employer’s retirement plan may be a good choice if the plan allows it and the investment options are excellent.
“As you debate whether to roll over your former 401(k) plan into your current plan or a rollover IRA, start by reviewing the fund options in your 401(k) plans,” Farnam says. “Be on the lookout for low-cost investments like exchange-traded funds and index funds.”
Check with research firm Morningstar to vet the investing options in your retirement accounts. When choosing between mutual funds, give preference to index funds and other funds with low expense ratios, such as a fund that charges 0.5% annually or less. Funds with lower fees mean you will keep more of your money and small differences in fees can translate into large differences in returns over time.
If you work for a large employer, use BrightScope to evaluate the plan’s investment options and fees. The website, which rates more than 45,000 retirement plans, will show you how your plan compares with plans sponsored by other employers.
For plans not listed on BrightScope, check with your human resources department or benefits administrator for information about the fees you pay to invest in your employer’s retirement plan. Last year, the Labor Department required employers to provide clearer descriptions of plan costs to employees, which will help inform whether you’re better off leaving your money where it is, or moving it elsewhere.
Note: Not all employers have to hold on to your money in their retirement plans once you leave a job. If your balance is under $5,000, or you’re over 62, some plans will automatically distribute balances to employees. Plus, a past employer can make changes to its retirement plan without letting you know.
“Part of the risk with leaving your account with a former employer is that they’re not required to inform you if they change plan administrators, which could make it more difficult to keep tabs on your retirement money and your investment options,” Farnam says. Fortunately, an account aggregation tool, like LearnVest’s Money Center, can give you a sense of your total retirement assets, and any changes in them.
Option 2: Transferring Your Balance to a Current Employer’s Retirement Plan
Before you move your balance to a new employer’s retirement plan, contact your HR department or plan administrator and find out if the plan accepts rollovers. Not all do.
Also, make sure to ask about a plan’s waiting period. Some plans can take weeks or months to process a rollover. That would leave your retirement savings in limbo. If you don’t want to live with that uncertainty, and depending on the number of your retirement accounts you want to consolidate, consider opening an IRA in the interim.
But employer-sponsored retirement plans, such as 401(k)s, offer several advantages over IRAs. The first is the higher contribution limits: In 2013, you’re permitted to contribute up to $17,500 per year into a 401(k) if you’re 49 years old or younger, and up to $23,000 if you’re 50 or older. For IRAs, you can only contribute $5,500 per year if you’re 49 years old or younger, and up to $6,500 if you’re 50 or older.
The second advantage of a 401(k) plan is your employer potentially matching a portion of your contributions: In other words, free money for the taking! More than 95% of 401(k) plans offer matching contributions from employers. An employer is allowed to match up to 6% of your salary, and the average match is 2.5% of pay. You should probably try to contribute enough to your employer’s plan to receive the match.
The last factor to consider is that nearly 90% of 401(k) plans allow participants to borrow from their accounts, should they need to. Loans are not permitted with IRAs, but you can withdraw penalty-free from a 401(k) for a first-time home purchase or qualified education expenses if you’re under age 59½. Just know that the terms of the loans vary greatly depending on the employer, and borrowing this way is usually a bad idea. “You lose the tax advantages of a 401(k) because you pay yourself back with after-tax dollars, and you lose time investing that money in the market,” says Farnam.
Option 3: Rolling Over Your Money to an IRA
Freedom and flexibility are the main draws of rolling your money into an IRA. Typically IRAs offer more investment choices than 401(k) plans. The average 401(k) has 19 investment options and most IRAs allow you to invest in thousands of stocks, bonds, certificates of deposit and mutual funds.
Using the extensive investment menu of an IRA, you will likely find lower cost options compared with those available in your employer’s retirement plan, especially if you work for a small company.
Rolling over a retirement balance to an IRA also allows you the opportunity to convert that money into a Roth IRA. This is especially helpful if you are in a low tax bracket or early in your career. In a Roth conversion, you will have to pay taxes on the amount that you convert, but you could save a lot in taxes later on because you’ll be able to withdraw your money tax-free after age 59 ½ when your income tax rates could potentially be higher than they are now.
How to Get Your Rollover Started
No, a rollover may not be your favorite way to spend an afternoon, but it could save you thousands of dollars. And, fortunately, you can enlist help from people who can walk you through the process.
When you’re ready, ask your HR department or retirement plan administrator for the distribution forms, which you need to fill out in order to roll over your account. The rollover process is a little different at each employer. If you’re rolling over a retirement plan balance into an IRA, contact the brokerage where you will open the account. Most have customer service reps to answer all your questions about the transfer and walk you through each step of the process.
Most importantly, make sure the money in the rollover is transferred directly to the new financial institution, not to you. If you receive a check, you have 60 days to deposit it with the new financial institution, according to I.R.S. rules. But don’t wait—do it pronto. If you hold on to the check from the plan past 60 days, you will face taxes and early withdrawal penalties on that money.
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