Retirement Account Rollovers: What to Consider

401k, Retirement

June 01, 2023

When you leave a job with a 401k you have an important choice to make. As long as you have at least $5,000 in the 401k you are typically allowed to keep it right where it is. Or you have the option of moving the money into your own IRA. This is called a 401k rollover.

A rollover can be a smart move. But only if you make smart decisions.

A recent study by Pew Research provides an eye-opening example of what not to do. Pew reported that there were more than $500 billion in rollovers in 2018. Typically, the funds inside a 401k qualify for the lowest possible annual fee, called the expense ratio. When that same fund is offered to retail investors in a regular IRA account it typically will have a higher expense ratio. And that cost can add up over time. Using just the 2018 rollover sum, Pew estimates that the cost of switching from the cheaper fund in the 401k to the same (but more expensive) fund offered in an IRA could cost investors $45 billion over 25 years.

That’s indeed a costly mistake. But one that is entirely avoidable when you do a rollover. Let’s walk through what to consider when you leave a job.

  • Does the 401k offer funds that charge very low annual expenses?
    By low I mean less than 0.20%. There are plenty of great index mutual funds and ETFs you can own in an IRA that charge less than 0.20%. If your 401k charges low fees and you want to stay put, that’s great. Typically, the bigger your employer, the more likely your retirement plan has low-cost investing options. But if you work for a smaller employer, the annual expense ratio for funds in your plans may be higher. If your 401k funds charge more (some charge 1.00% or more) you should consider a rollover.

  • Do you have more than one old 401k?
    As retirement nears and you start to carefully plan how you will generate income from your investments, it can be a royal pain to coordinate multiple 401ks at different employers. Moving them (rolling over) under the roof of one account at a brokerage can make a ton of sense.

Once you decide to do a rollover, there is one fairly easy way to make sure you keep your costs as low as possible: Invest your rollover IRA in low-cost index mutual funds or exchange-traded funds (ETFs).

Every major discount brokerage offers these investment options.

An index mutual fund or ETF whose name includes “Total Index” will own a broad mix of U.S. stocks. There will also be an international stock index fund or ETF.

For your bonds, there are likely many choices. A “Core” index fund is likely similar to what you had offered in your 401k. Core bond funds invest in a mix of government bonds and high-quality corporate bonds. For those of you near retirement, I recommend investing solely in Treasury bonds, or a fund that owns Treasuries and other government-issued debt.

Every brokerage will have a few of these “government” bond funds, that invest in bonds of different lengths. Short-term and intermediate-term can be good options. They don’t yield as much as long-term government funds. But when interest rates rise, the longer the bonds, the more your portfolio will lose. Shorter-term bonds react less to rising interest rates. OKAY?

As I explain in detail in my book, The Ultimate Retirement Guide for 50+, owning just three index funds or ETFs is all it takes to have a solid retirement portfolio. You can always build on that, but a US total market fund/ETF, an international one, and a bond fund/ETF is a terrific core.

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