Roll Your 401(k) Over Into an IRA

It would never occur to me to give out some bits of advice if somebody else hadn’t first suggested an unwise alternative. Some things seem just so obvious and uncontroversial that writing them up would be pointless. Then I read something that reminds me this is the personal finance world I am talking about.Smart Money Map

Case in point is rolling your old 401k over into an IRA when you leave your job. According to the Wall Street Journal’s Smart Money, this is not the no-brainer I foolishly assumed. It is a conundrum. Who knew?

In case you are not up to speed on the deal with 401ks once you stop working where the 401k lives, you basically have four choices. You can cash out the money in the form of a distribution, on which you will pay income taxes and, assuming you are under 59 1/2, an additional 10% penalty. That’s probably not a good idea unless you seriously needed the cash. (For example if you just lost your job.)

Second, you can also often just leave the money where it is. Many employers will allow ex-employees to maintain accounts indefinitely. Or third, if you have a new job with a new 401k plan, you can transfer the money from your old 401k to the new one.

But the best course of action for just about everybody is to roll the 401k over into an IRA. The biggest of several motivations for doing this is that you can then invest your IRA in almost anything you want to, in contrast to your 401k, which is generally limited to a menu of a dozen or so mutual funds. It’s also likely to make dealing with your investments a little simpler. If you’ve already got an IRA, having your assets in the same place makes things easier and even if you don’t, you’ll probably find that dealing with the broker or mutual fund company that holds the IRA is easier than dealing with your (former) company’s HR department.

On the other hand, coming up with reasons why moving your 401k to an IRA could be a bad thing is so hard that it quickly devolves into a game of personal finance trivia.

The best one I can come up with is that if there is an investment option in your 401k that you like and that would not be available in an IRA, you might not want to switch. That is a pretty unlikely situation. I will unscientifically guess 1% of people might run into it. Sometimes there will be special lower-fee versions of mutual funds only available to 401ks. And very rarely there are non-public funds available in 401k plans.

After that, the case against rolling over gets into obscurities. Some states treat IRAs in less advantageous ways than 401ks in bankruptcy. The rules for spousal consent for changing beneficiaries are different. And if you are planning to retire between the ages of 55 and 59 1/2 you’d rather be in a 401k for reasons I am not going to pretend to understand.

I often harp on the point that one-size-fits-all personal finance advice is unwise, but this is one of those situations where a universal rule almost works. For most folks, there’s just not much to talk about. Search the web for advice on this and you won’t find very much because few writers think it is worth mentioning. A recent post on Smart Money’s sister blog The Wallet discusses a variety of issues surrounding 401ks if you are laid off and mentions, in passing and without discussion, that rolling over into an IRA is what most planners advise.

And yet as of last week Smart Money does not see this as a non-issue. Apparently, the argument that IRAs are more flexible and convenient than 401ks is just another trick that the brokerage and mutual fund industry uses to get your business. Turns out they all have websites that try to convince you to open an IRA. Bastards.

I am a great believer in the maxim that you should never ask the barber if you need a haircut. Nevertheless, sometimes you do need a haircut even if he says so.

Why does Smart Money warn you away from IRAs? The primary argument seems to  be that this is what fund companies want you to do, so it must be a bad idea. The only other one mentioned is, of all things, fees. "Investors in a 401(k) plan often pay much lower fees than retail investors—sometimes half as much." Really? Didn’t many news outlets, The Wall Street Journal included, just last month run with the story that 401k fees were so high that Congress was considering reform? I’m so confused.

I am not going to speculate on what sort of need to write something under a looming deadline caused this particular piece to be born. But with all the actually controversial topics and areas of confusion available as subject matter, there’s really no need to muddy up the waters here.

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