Financial Advice for Retirement, Social Security, IRAs and Estate Planning

How to Make the Most of Your 401k Plan for a Wealthier Retirement

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Rollovers from 401(k) accounts are the main reason IRAs are among the most valuable assets many retirees own.

When people leave a job, for either a new one or retirement, they often roll over the 401k balance to an IRA.

To maximize the value of your IRAs in retirement, you need to maximize 401k account balances during your working years.

Many 401k plans have improved in recent years, but there are still too many mediocre plans out there.

(I regularly hear readers complain that their plans don’t have good investment options or they cost too much.)

Often, there are actions you can take to boost your 401k returns, even when your plan isn’t one of the best.

Even 401k plans that have many shortcomings often offer one good option known generically as the brokerage window.

Your plan might give it a different name, such as “self-directed option.”

Some plans don’t publicize the option well, almost hiding it from participants.

But it’s a good option for a reasonably knowledgeable investor, especially one who has a relatively valuable account.

The brokerage window allows plan participants to bypass the plan’s mutual fund options by opening an account for their 401k plan at a broker selected by the employer.

In other words, it’s a brokerage account within your 401k account.

A few 401k plans allow a brokerage window account to be invested in anything offered by the broker. But most employers limit the investments that can be purchased through the brokerage window.

The limits are not nearly as severe as the plan’s standard fund offerings. Most plans allow members in the brokerage window to invest in almost any mutual fund, exchange-traded fund (ETF), stock and bond available through the broker.

They generally don’t allow selling short stocks or investing in futures and options.

The limits exist because the law imposes some responsibility on employers to ensure participants are educated enough to make appropriate investment decisions.

Employers are afraid they’ll be sued if a participant’s investments do poorly. (A number of employers require participants to sign statements before allowing access to the brokerage window.)

The statements generally affirm that the participant is an informed or experienced investor and knows the risks of investing outside the plan’s mutual fund offerings.

The Department of Labor in 2012 floated the idea of making employers responsible for the consequences of any investment selected by 1% or more of its plan participants.

The proposal was withdrawn, but it has increased caution among 401k sponsors.

Other potential benefits of a brokerage window are that it usually allows online investing, and unlimited trades can be made, and will be executed at the same time as other clients of the broker.

This contrasts with the practice of many 401k plans to limit the quantity of trades and the time periods when trades will be executed.

If your 401k offers a brokerage window, you probably can invest in my recommended portfolios or those of most other newsletters without much trouble.

A brokerage window usually has an annual fee of $100 or less. Fees are likely to be charged on all or most of the transactions you make through the brokerage window, though you might have access to no-transaction-fee funds.

The funds available through the window also aren’t likely to be the low-expense institutional share classes that should be offered by most 401k plans.

There are some details you need to check before selecting the brokerage window.

For example, when contributions are taken from your pay, when will they be received in your brokerage account?

Will the broker automatically allocate the contributions as you designate in advance, or will you have to do that manually each pay period?

Of course, you want to know the cost of each transaction. Also, be sure to confirm whether there are additional costs for transferring money from the brokerage window back to the 401k account, to you, or to an IRA.

The 401(k) plan brokerage window is not for everyone. If you want a traditional portfolio and your plan offers decent funds, stay within the standard plan.

But if you want to duplicate my recommended portfolios, or the plan offers low-quality or high-expense funds, or has very limited choices, take a look at your plan’s window.

When your plan doesn’t have a brokerage window, tell the Human Resources Department or other relevant authorities that you’re interested in one.

Participants who are at least age 59½ might have another option to increase their 401k account returns or reduce expenses.

Few people are aware of it, but many employer plans, not only 401k plans, allow what’s called an “in-service distribution.”

Once a participant reaches age 59½, the tax law allows a rollover or penalty-free distribution.

Unlike for younger participants, there is no requirement that the worker leave the employer’s service in order to avoid the 10% early distribution penalty. You can stay in the same job and still empty the 401k account.

Under the in-service distribution rule, the account can be rolled over tax-free directly from the 401k plan custodian to an IRA custodian. Or the worker can take the distribution, pay income taxes on it and invest the remainder.

Since the worker continues with the employer, new contributions can be made to the plan. It is also not an all-or-nothing option.

The law, and most plans, allow the employee to take an in-service distribution of less than the full account balance if desired.

Not all plans allow the in-service distribution, but many do, especially plans of large employers.

There are several reasons to consider an in-service distribution.

Of course, if the plan has poor investment options, high expenses, or other problems, it’s a good idea to move the money to another investment vehicle as soon as possible.

You also might want to move some or all of your 401k to an IRA when the plan doesn’t offer all the investment opportunities you want.

The in-service distribution might be more convenient and less expensive to you than using the brokerage window.

Keep in mind that since 2008, the IRS has allowed a traditional 401k balance to be rolled over to a Roth IRA.

This would be a conversion, so the converted amount must be included in gross income. But it is a simple way to convert a traditional 401k account to a tax-free Roth account without waiting until you retire.

The in-service distribution isn’t for everyone. When your plan has reasonable costs and offers funds that meet your needs, especially if it has the low-fee institutional shares, it might be worth staying in your 401k.

Also, keep in mind that a 401k might have features you won’t find in an IRA. For example, you can borrow from your 401k account but can’t borrow from an IRA.

Also, if employer stock is in your 401k account, it usually shouldn’t be rolled over to an IRA. More favorable tax treatment is available by distributing the stock to a taxable account as part of a full lump sum distribution.

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