401k or 403b, Rollover to an IRA or IRRA. Good Idea?

John J. Hohn and dog Jessie
#401(k)  #403(b)  #rollover  #ira
One of the first questions that you will face as a new retiree or after changing jobs is what to do with your 401k or 403b* retirement account that has been building up over the years. Leaving it with your former employer is usually one option, and it may appear attractive for several reasons.*

If the investments in the plan have done well, moving it may mean starting all over with a new manager. It may be a repeat of the old saw, “If it ain’t broke, don’t fix it.” Your former company may continue to pay the fees associated with the account so that you do not need to assume that expense. Finally, a known always seems better than an unknown, or at least it is more comfortable.

If you take your decision to a financial advisor, expect to be advised to move it, so that the advisor or the firm he or she represents can take over the management of the funds.

I always urged clients to move the funds. Of course, I stood to benefit from the decision, but even now that I am retired, I would still recommend that friends and family take the same step. For one thing, managers of 401k or 403b plans are not usually proactive on behalf of the individual plan participants. You would not expect them to call and suggest changes in your investments, for example, if there is a change in the market or the economy. They usually offer several options and a few rules of thumb to help you make a reasonable selection among the funds available, but up close and personal consulting is not usually part of the package.

If you have not had experience working with an advisor, broker, or company representative on a personal level, be prepared to discuss the level of risk you are willing to accept, your individual goals and concerns, and other unique considerations as part of the basis for your plan. The advisor will have a vested interest in seeing your account do well. Your former employer’s plan management will not bring the same level of service to the relationship with you.

Shop around. Visit with different company representatives. If the representative does not develop a full picture of your situation during an interview, covering all the topics mentioned earlier, then move on to the next person or company on your list. Companies serve different segments of the market. Some, like Merrill Lynch, Morgan Stanley, and UBS Paine Weber, are looking for affluent clients, people who can bring in at least $250,000 to invest, or better yet, $500,000. If your portfolio is not that large, find a company that targets the average middle-income investor. You will get better service. Better be seen as a big fish in a small pond than a small fish in a big pond.

When it comes to fees, you need to look at a couple of things. First, some companies will charge an annual account fee. An annual account fee covers the costs of producing regular statements for you, providing the accounting of your holdings, issuing any required end-of-the-year tax statements, and providing insurance—SIPC—which is much like FDIC at a bank. Annual account fees are usually nominal in amount, ranging from $25.00 to $60.00. But, again, many good companies offer no-fee IRA’s as an inducement to new customers.

In addition, you may be required to pay an investment management fee or a commission on the investments you make. Explore these fees thoroughly with the representative or advisor before making your decisions. Some so-called “no-load” funds appear to be the best deal, but close inspection may show that they charge an annual management fee and it is taken out of your fund’s proceeds before your returns are calculated. You may see the fee that you are paying if you do not ask for the information. It is in the fund prospectus.

Investors often make fees the most important consideration in the investment decisions that they make. The fee is set. It is certain. The promised returns are simply that—promised. Fees need to be justified by the returns that the investments have generated over time. Thus, a 2.50% fee for a fund that has generated an average net return of 8.00% over the past 20 years is a better buy than a fund that charges a .75% fee but has generated an average return of 5.50% over the same period.

Moving the funds of a 401k or 403b plans—often referred to as defined contribution plans—involves very little risk in itself if it is handled properly. Funds in a defined contribution plan will not be subject to taxation if they are rolled over into an IRA (individual retirement account), or sometimes call an IRRA (individual rollover retirement account.) The process may take up to six weeks to complete depending on the defined contribution plan manager accounting and the transfer process itself. Since the transfer is from one tax deferred account to another, no capital gains taxes will be assessed against the sale of any assets. The phrase deferred tax account means simply that the money in the account will only be taxed when it is withdrawn.

The purpose of a defined contribution account is to supplement social security income during retirement. If funds are withdrawn prematurely, before the participant attains age 59 ½, the amount withdrawn will be treated as income for the year of the withdrawal and an surcharge of 10% will be added. The withdrawal needs to be added to other income for tax reporting purposes and may push the participant into a high tax bracket. For this reason, the advice of a tax accountant or tax attorney should be sought before making the transaction.

One of the most important considerations before rolling over a defined contribution plan account (a 401k or 503b) is to determine if the plan holds any post-tax, or after tax, contributions. Post-tax contributions were made by having money deducted from a regular salary or wages after the income tax had been deducted. The plan participant should have record of the contributions. The post-tax contribution should be rolled over into a separate IRA from the pre-tax contributions, or the contributions that were made prior to having income tax withheld on wages or salary.

A separate IRA for post-tax contributions will simplify tax reporting on withdrawals. On post-tax contributions, the amount of the original contribution is not taxed when it is withdrawn. Only the dividend and interest income and the capital gains that were accumulated are subject to taxation on the withdrawal.

A separate IRA for pre-tax contributions completes the portfolio. Since pre-tax contributions were deducted prior to any withholding for income tax purposes, the entire amount of any withdrawal is subject to income tax in the year in which the withdrawal is made. It may seem like a lot of trouble to have two IRA’s, and it may add nominally to the expense of maintaining a retirement portfolio, but savings in taxes and the simplicity in reporting are well worth the trouble.

Most likely the defined contribution plan will liquidate your holdings and transfer cash. You must then decide upon how to invest the cash once it appears in the new IRA’s. The advisor or company representative is there to help you with these decisions. The subject itself is beyond the scope of this article, but keep watching this site for more help on investing your retirement savings.
*Retirement plans are most frequently designated 401(k) and 40(3b). I have dropped the parenthesis for this article because Internet search programs stop reading when a parenthetical statement is encountered.

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