American workers often change jobs and must decide what to do with their 401k balances at their prior employers. I’ve worked as a 401k plan consultant for more 30 years, with companies like Apple and AT&T, so I am an advocate for 401k plan participants and have dealt with this situation many times. For the vast majority of 401k plan participants, in my experience, it does not make sense to roll over their 401k balances from a prior employer into an Individual Retirement Account, or IRA.
Below are the reasons why.
Stable value funds are not available
Most 401k plans offer stable value or guaranteed fund investment options as their safe choice, rather than money market funds.
Money market fund yields have been far below stable value or guaranteed interest fund rates for many years. It is likely that yield differential will continue.
For conservative investors or 401k participants close to retirement, access to stable value/guaranteed funds during this low-interest rate period has been an absolute godsend.
It is difficult, and most times impossible, to find stable value or guaranteed fund investment options available to IRA account holders.
As a result, an investor’s safe investment option in an IRA rollover account will likely be a low-interest money market fund or cash — not the best options.
IRA advisors may not be fiduciaries
IRA account investors should be concerned about whether the investment options their advisor is recommending benefit the advisor more than the investor. It is very possible that their advisor is not acting as a fiduciary when making investment recommendations.
That means the advisor is not required to take the client’s best interests into consideration. As a result, any investment recommendations made may be good for the advisor and for their firm, but not for the investor.
In a 401k plan, not only is the employer required to be a fiduciary, but the investment advisor associated with the plan is likely to be one as well.
Which approach do you think yields better investment opportunities?
Performance differentials are substantial
According to the Center for Retirement Research, the average return in an IRA for the 12-year period of their study was 2.2%. The average return in a 401k-plan account for the same period was 3.1%.
Although neither of these returns will allow anyone to retire anytime soon, there is a huge difference between the two. The return 401k plan participants experienced was nearly 41% greater.
Study results like this prompted President Barack Obama to ask the Department of Labor to issue fiduciary regulations governing IRA rollovers. Unfortunately, those regulations were subsequently rolled back.
IRA rollover = higher fees
The main reason cited in the Center for Retirement Research study as to why the return differential between 401k plans and IRAs was so large was that IRA investors paid much higher fees.
Average 401k balance limits options
The average 401k account balance in 2017 for the average American worker was a little more than $100,000. Unfortunately, there aren’t many advisers who are eager to work with IRA rollover accounts this size.
As a result, the average participant will either pay excessive fees with the larger advisory firms or work with discount brokerage firms or mutual fund companies where no objective investment advice is available.
Objective investment advice options are few
The average 401k plan participant considering a rollover has limited options to obtain objective investment advice. Advisers at large brokerage firms are conflicted because of their desire to generate transaction fees and recommend investments that pay them well.
Those mutual fund families that provide investment advice aren’t objective because they are asset managers first and as a result tend to over-recommend their funds. They are not eager to recommend investment options outside their fund families that may be better solutions.
Very few advisers are willing to take on small-balance business without substantial fees. Balances under $1 million may be subject to annual fees as high as 2%.
However, most 401k plan participants can receive objective investment advice from the advisor attached to their 401k plan – at no cost.
IRA rollover balances are too small to meet minimums
Nearly all of the cheapest mutual fund share classes available to investors outside of retirement plans have minimums far in excess of the $100,000 average participant balance. Many are $1 million or more. As a result, the average 401k plan participant who rolls a balance into an IRA will often end up investing in one of the most expensive retail share classes.
Nearly all 401k plans use low-cost institutional or R6 share classes. The difference in cost is at least .50% to 1%.
Transaction fees are likely with IRAs
Many brokerage firms, banks and insurance companies are interested in creating transactional revenue. As a result, not only are IRA rollover account holders investing in higher cost funds, but they are also likely incurring transaction fees on purchases and sales.
Remember that 401k plan participants have access to free, objective investment advice and low-cost investment options. They can make purchases/sales and transfers without any transaction costs.
IRAs offer less protection from creditors and lawsuits
Your 401k-account balance is shielded from attachment by creditors if you declare bankruptcy. In addition, your 401k balance cannot be included in any lawsuits.
IRA account holders do not enjoy the same level of legal protection and are subject to state laws, which vary.
Early retirement withdrawal penalties with IRAs
Many 401k plans allow participants to retire beginning at age 55. Under the law, these early retirees can take penalty-free withdrawals from their 401k accounts.
IRA account holders who retire and take withdrawals before age 59½ are subject to a federal penalty tax of 10% and possibly state early withdrawal penalty taxes as well.
Loans are not available
You can’t take a loan from your IRA but you are probably eligible to take one from your 401k plan. Although I am not a proponent of 401k loans, this is an important option to have in the event you run into a financial emergency and can’t get a loan from a bank.
Rolling into your current employers 401k is a much better option
It is nearly always a good idea to roll over your former employer’s 401k balance or your IRA into your current employer’s 401k plan, for all the reasons outlined above.
In addition, it is easier to manage your retirement plan nest egg if it is all in the same account. And you will receive more comprehensive investment advice.
As an advocate for 401k plan participants, I am concerned that very little of the information necessary to make a good rollover decision is shared with participants in a manner they can understand.
Most participants only receive information about rollovers from an advisor who is trying to get them to roll over their money and who is therefore conflicted.
As a result, I believe most investors make bad decisions when they decide to roll over their 401k plan accounts to IRAs.
Robert C. Lawton, AIF, CRPS is the founder and President of Lawton Retirement Plan Consultants, LLC. Mr. Lawton is an award-winning 401(k) investment adviser with over 30 years of experience. He has consulted with many Fortune 500 companies, including: Aon Hewitt, Apple, AT&T, First Interstate Bank, Florida Power & Light, General Dynamics, Houghton Mifflin Harcourt, IBM, John Deere, Mazda Motor Corporation, Northwestern Mutual, Northern Trust Company, Trek Bikes, Tribune Company, Underwriters Labs and many others. Mr. Lawton may be contacted at (414) 828-4015 or bob@lawtonrpc.com.