Why I Roll Over my Old 401Ks
Like many thirtysomethings, I’m on my third job since college. At this rate, I will have ten, maybe eleven, jobs before I retire. Each job will likely offer me a new retirement plan. In my sixties, I could have ten or more separate work-sponsored retirement accounts, each with their own logins, passwords, and fees.
Instead, I have rolled over my old work retirement accounts to an individual retirement account (IRA), and believe that more millennials should do the same. Currently, the average 25-34 year old has a 401K or 403b that they have left behind at a previous job. I want to put “401K rollover” on the “I-just-got-a-new-job checklist” right after posting a LinkedIn status update and scheduling a fun employment vacation. Here’s why.
When you change jobs, you have four options for dealing with your work-sponsored retirement account:
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Cash out
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Keep your money where it is
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Roll your account to your new employer
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Roll your account to an individual retirement account (IRA) through a financial services company like Vanguard, Schwab, or Blackrock.
Before going into the specific options, it’s important to note that a 401K, 403b or an IRA are accounts. Within these accounts, you can choose between a variety of investing options with different fees, risk profiles, and returns (aka how much they will grow). You can think of an IRA or a 401K like choosing the restaurant where you want to eat. Once you’re there, you have a variety of menu options at different price points, flavor profiles, and nutritional value. An employer-sponsored plan offers curated investing options. When you’re in an employer-sponsored plan, you don’t get to choose the restaurant. If your employer has chosen Chipotle, you can choose a Carnitas burrito or a vegetable burrito bowl, but you’re out of luck if you’re in the mood for tomato bisque. In contrast, choosing an IRA gives you the choice of what restaurant to go to and what menu options to select. You can choose to go to Whole Foods where you can affordably eat sushi, pizza, or the hot food bar, but you can also choose a fancy restaurant or a private chef at a higher price point but with more personal attention and tailored meal options.
Returning to the four options you can choose from, cashing out your retirement account is the worst option. When you cash out a retirement account, you generally have to pay taxes and an early withdrawal fee of 10%. In addition, you are effectively resetting the clock on starting your retirement savings growth.
Weighing your Options: 401K or 403B Rollover
Once you rule out option four, there are three viable options. I’m lumping together the next two options (keeping your money where it is or rolling your account to your new employer) because they have similar downsides. There are three key disadvantages to keeping your money where it is. The first two disadvantages also apply to rolling your money to your new employer’s plan.
401k & 403b fees
First, retirement accounts have fees and these fees are hard to identify and compare. If you’re going to keep your money somewhere, you should know what it costs. However, plans can charge a mixture of account fees, load fees, and then investment fees (often called expense ratios which doesn’t even use the word fees!). While these fees are required to be disclosed in a ERISA 404a Participant notice, finding this form on your plan’s 401K site and then figuring it out how the different fees will impact you is a challenge. If you are going to change jobs multiple times in your career, leaving your money where it is or rolling the money to your new employer means you will have to dig in on your old and new plans fee disclosures every time you move employers. These fees might seem small and insignificant but a difference in just 1% in fees can have more than $500,000 impact on your retirement. In addition, as an ex-employee you may be charged higher administrative fees that can further eat away at your retirement.
Second, employer retirement plans have limited investment options. Some employer plans offer fewer ten investment options. Some offer more investment options but few that are low fee. For example, in my current plan the Target date fund options are expensive with expense ratios of over 1%. Target date funds are a great option for retirement because they shift their allocation from riskier stocks to more conservative bonds overtime. This keeps the investor from having to rebalance each year. If your plan only offers expensive Target date funds this can force you to choose between the “right” options for you and minimizing your fees. In addition, if you want to invest in socially-good funds or adopt another custom strategy, you probably won’t have access through your employer plan.
Third, if you choose NOT to roll over, you can end up with a large number of retirement accounts. Fewer accounts means more than just fewer passwords; it’s also easier to estimate your savings. Most importantly, having your money invested across multiple accounts makes it very difficult to create a coherent investing strategy. Most financial experts advise that you invest in risky assets like stocks when you’re young and shift to more conservative investments like bonds as you get closer to retirement. This allows you to maximize growth but also protects your wealth in case of a market downturn. A common rule of thumb says you should have 110 minus your age in stocks e.g., a 33-year old would have 77% of their money in stocks. When your retirement is held across five or more plans, it is very challenging to manage your investing allocations.
The above reasons lay out the downsides of keeping your money where it is or rolling your money to your new employer’s 401K.
Advantages of Rolling over Your 401K or 403B
The first is you can pick an IRA provider who is known for their commitment to low fees with a lot of investment variety. Certain IRA providers like Vanguard, Blackrock and Schwab are known for their transparency and commitment to low fees. Many charge no administrative fees on IRAs with over $10,000 and offer expense ratios less than 0.2% on a large variety of investments. In addition, while a 401K or 403b will offer a curated list of investing options, an IRA will give you access to a much larger list of funds including stocks, bonds, and money market funds. The going wisdom used to be that the buying power of a large 401K plan would get you better pricing than going it alone. However, in a world where there are NO-fee mutual funds, you don’t need your employer to get access to cheap investment options. Plus, if you want to invest in socially-good funds or adopt another custom strategy, you probably won’t have access through your employer plan to customize but could have access through an IRA.
Second, you can see all your money in one place. As noted above, most financial experts advise that you invest in risky assets like stocks when you’re young and shift to more conservative investments like bonds as you get closer to retirement. It is much easier to make sure your money is invested strategically and that your savings are on track for retirement when it is in one account with one password and one fee disclosure. If you want a more hand- off investing strategy, you can put your money into a Target Date fund within an IRA allowing your stock and bond allocation to be shifted for you.
Third, even if you’re 401K, 457 or 403b is performing well, you can probably get that same growth at a lower cost in an IRA. I sometimes hear that peers don’t want to roll over an old 401K because it is “performing well.” However, your retirement accounts are invested in stocks and bonds from the broader market. The market performed very well in 2019 (the S&P is up 29% YTD as of December 26, 2019). Therefore, you want to compare how well you performed in your employer 401K or 403B plan against an option with comparable risk in an IRA. I’ll use the example of the 2050 Target Date fund in my current employer’s 401K. This fund had a YTD return of 15.9% as of December 26,2019. That’s pretty good until you compare it to the 24.63% YTD return with a Vanguard 2050 Target Date IRA. Plus, my company’s Target Date plan charges a 2.21% investment fee compared to Vanguard’s 0.15% fee for their Target Date IRA. On $10,000, that’s $1,082 I hand over in fees. On $50,000, it’s $5,410. Every year that investment return compounds, so the money you lose in fees now really hurts your savings in the long run.
Market returns vary, but fees are guaranteed. I will pay that 2.21% fee if the market returns 29% or 0%.
Personally, I have had three jobs ranging from a publicly-traded technology firm with low-fees to a start-up with no 401K match and higher-priced investment options. I have picked my jobs because of the salary, the people, and the values of the company. I haven’t ever picked a job based on the strength of the retirement plan. Instead of spending time struggling with where, what and how to roll over your 401K every time I leave a job, I set up an IRA somewhere I trust with low-fee, broad investing options.
When you do NOT want to roll over your retirement account
There can be good reasons to NOT roll over an old 401K or 403b. For tax reasons, it’s generally not a good idea to roll over company stock that has appreciated in value. Second, if you’re afraid of bankruptcy or are planning to retire early, leveraging your current employer’s 401K or 403b provides additional protections from creditors and can allow you to take out funds before age 59 ½. Finally, while this is not a reason to avoid a roll over to an IRA, it’s important to note that many financial or tax professionals will get a commission if you roll your dollars to an IRA, but not if you roll your dollars to your new company’s retirement plan.
bottom line:
For most millennials, rolling over your old retirement accounts to a low-fee IRA is a prudent financial decision. You can get both low fees and a lot of variety, and you can feel confident you’re always getting a good deal. When I’ve asked friends why they haven’t rolled over old 401Ks or 403bs they’ve responded with a mixture of “I’m so lazy” to “I want to look at the returns I’m getting to make a decision.” If you decide to roll over once and set up an investment strategy you feel good about, you will cut down on the need to make this decision every time you move jobs. Your future self will thank you.