Should You Roll Over Retirement Funds or Stay Put?

More money than ever is moving from 401(k)s to IRAs, and regulators don’t like some of the choices people make with their money. More than $600 billion was rolled over from 401(k)s to IRAs in 2020, according to the Secure Retirement Institute (SRI), which estimates that within five years the annual rollover amount will exceed $750 million.

The rollover is the most frequent IRA transaction. The IRS reports that rollover contributions to IRAs greatly exceed regular IRA contributions. The growth of rollovers triggered a series of on-and-off regulations from the federal government. The current regulations in effect are from the Securities and Exchange Commission (SEC) and are known as the Best Interest rules.

Some financial advisors and financial services firms have said they will no longer give advice about retirement plan rollovers because they aren’t sure they can comply with the regulations. The regulators were especially concerned that people were being talked into taking money out of low-cost 401(k) plans to roll it over into alternatives, especially high-cost variable or indexed annuities, that rewarded the financial professionals. You don’t need regulations to en- sure you make good decisions about your 401(k) and IRA money. Fol- low my simple guide to making the right decision about your retirement funds.

The issue of whether or not to rollover retirement funds usually arises when a worker leaves an employer. A departing employee usually has these options for the 401(k) account: leave the money in the 401(k) plan (though a few employers still discourage this); transfer it to the 401(k) plan of a new employer, if the new plan allows; have the account distributed directly to you; or rollover the account to an IRA.

I’m going to assume you’re retiring and so transferring the money to a new employer plan isn’t an option. Also, you don’t want the account distributed to you unless you really need the money, because the entire distribution would be included in your gross income and taxed. The real choices are to stay with the 401(k) plan or roll over the account to an individual retirement arrangement (IRA).

Start by taking a fresh look at the 401(k). Does the plan have features that make it attractive on its own? The details of 401(k) plans vary considerably. Though 401(k) plans have improved a lot over the years, many still aren’t attractive on their own. That’s more likely to be the case with plans at small- and medium-size employers, though some large employers also don’t have very attractive plans. An attractive plan has low expenses.

A recent survey by the Government Accountability Office found that a high percentage of 401(k) participants didn’t even know their plans have fees and expenses. Many plans charge an annual fee to each account. In addition, the investment funds offered by the plan have their own fees and expenses. These and other expenses are disclosed to participants in documents issued by the plan (or available on its website).

Many employers, especially large employers, have worked hard to drive down plan costs, particularly investment management fees. Their plans invest in the “institutional shares” of funds, which charge the lowest fees of any share class. Some employers also subsidize annual costs, such as recordkeeping and administration fees. If you haven’t done so, review the documents and learn the plan’s costs.

Next, consider the investment options. Does the fund offer a number of asset classes or only a few? Are the funds offered high performers in their categories or are they mediocre or worse? Are all or most of the funds from the same investment management firm? An IRA would allow you to invest in almost any publicly available security or fund, plus some other opportunities.

You don’t need that many investment choices, but you might want more than the 401(k) offers. An attractive 401(k) plan offers a range of asset categories instead of just the basic five or so. Also, in each category it has a low-cost fund that consistently offers solid returns relative to indexes and similar funds. A really good 401(k) plan has customized target date plans or similar asset allocation funds that are better than the off-the-shelf products offered by most fund families.

A complete 401(k) plan has a brokerage window that allows you to in- vest in most or all of the investments available through a broker selected by the plan at a reasonable cost. Many 401(k) plans also offer options not available through most IRAs. You might be able to invest in a stable value fund or convert all or part of your balance into an immediate annuity that pays income for life. Compare current payouts available from the plan’s annuity to those you could obtain from insurers as an individual buyer.

Consider the policies and rules of the 401(k) plan. Many plans limit how often changes can be made in invest- ments and when money can be taken from the plan. Learn about any such limits and decide if they’re important to you.

Most IRAs don’t have these restrictions. Examine the distribution options for both you and a beneficiary. Some 401(k) plans offer limited ways to take distributions, while others offer the same flexibility as most IRAs. Some 401(k) plans give beneficiaries more limited distribution options than IRAs do.

For example, I recently received an email from a widow who was told if she didn’t roll over her late husband’s 401(k) account to an IRA within a limited time it would be distributed to her, which would be taxable. A potential negative result of staying with the 401(k) plan is that it might prevent you from consolidating your investment assets at one financial services firm.

Some 401(k) plans make it difficult for retirees to receive communications or learn what’s going on with the plan.

The employer makes the communications available through its internal email and other electronic services. These aren’t readily available to retirees and other former employees. Don’t compare the 401(k) only with the IRAs offered by the 401(k) plan administrator.

Another concern of regulators was that 401(k) plan administrators have an advantage and steer plan participants to their own IRAs when lower-cost, more flexible IRAs are available. Take a close look at the fees charged for all services at both types of plans.

Some IRA custodians offer “no-fee IRAs,” meaning they don’t have annual maintenance fees, but they charge fees for many transactions. A good way to compare the 401(k) plan to IRAs is to decide the types of assets you’re likely to invest in and the transactions you’re likely to make in the future.

Then, decide which vehicle is going to be the best fit for your likely future needs. The SRI says about 25% of departing employees leave their money in the 401(k) plans. I suspect that number increased in recent years and will increase more as 401(k) plans improve their features.