4 Cautions for 401(k) Rollovers

Question: What should concern me when I rollover my 401(k) to an IRA?

Answer:  Last week I wrote about the possible benefit of rolling your former company’s 401(k) to an IRA when you retire. (Click here to read Part 1: "What You Should Know About 401(k) Rollovers.")   I also wrote about a special tax-saving benefit available to you if you own your company’s stock in your 401(k).  This week I will list what to watch out for.

1) Taxes and Penalties

If you withdraw money from a 401(k) account and don’t roll it over you will pay tax on it.  And if you are under age 59 ½ (fifty nine and one-half) you will pay an additional 10% early withdrawal penalty unless you meet certain exceptions.  Rolling your 401(k) into an IRA is usually a good idea, but it must be done correctly.  As I said last week, rolling over your 401(k) to an IRA at a brokerage firm can give you access to a better selection of investments, including stocks, bonds, ETFs, and mutual funds.  You can then be positioned to manage your investments for income and/or growth.

2) Don't Roll Your 401(k) Plan Into a More Expensive IRA

Some brokers and bank investment sales representatives sell mutual funds that charge upfront commissions as high as 5% and annuity products that pay the broker commissions as high as 9%.  These annuities won’t charge you a commission upfront, but will charge you annual administrative and insurance fees along with internal fund expenses that can add up to 3%--4% per year.  Beware of “free-lunch” seminars, where you will often hear compelling sales pitches for annuities. There are less expensive and better options for your retirement nest egg.

3) Potential for Reduced Protection from Creditors

One drawback to moving from a 401(k) to an IRA is that you may lose some protection from creditors. Federal ERISA rules protect 401(k) plans - but not all IRAs - from creditors should you ever go into bankruptcy.  However, California law does offer some protection for private retirement plans, including IRAs.  If you anticipate credit, legal, or bankruptcy problems you should consult your attorney before you roll over your 401(k).

4) Conflict of Interests

Brokers and Investment Advisors have an inherent conflict of interest when recommending that you move your retirement plan from a 401(k) to an IRA.  A broker representative may be rewarded for opening a specific number of rollover IRAs, and broker representatives may earn commissions and other fees.  Fee-only investment advisors may earn an asset-based fee on a rollover IRA that they would not earn if you kept your money in your 401(k) plan.  Broker representatives are required to have a reasonable basis to believe that a recommendation is suitable for you.  Investment advisors are subject to an even higher “fiduciary” standard and must believe that the recommendation is in your best interest.  Make sure that your advisor discusses his or her conflicts of interest and that you understand them.

In summary, always compare your 401(k) to an IRA for:

  • investment options,
  • fees and expenses,
  • levels of service available,
  • tax consequences,
  • protection from creditors and legal judgments,
  • required minimum distribution requirements, and
  • tax-saving options available to you if you hold employer stock in your 401(k).

Read Part1: "What You Should Know About 401(k) Rollovers"

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning.  Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to ken@montereypw.com.