Column: Where to park the 401(k) when you switch jobs or retire

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U.S. one-hundred dollar bills are seen in this photo illustration at a bank in Seoul
U.S. one-hundred dollar bills are seen in this photo illustration at a bank in Seoul August 2, 2013. REUTERS/Kim Hong-Ji/

Feb 9 (Reuters) - The old line that “you can’t take it with you” does not apply when it comes to your 401(k).

When you change jobs or retire, you have three basic choices: leave your retirement account where it is, roll it over to a new employer or move it to a standalone individual retirement account (IRA).

IRAs have been gaining ground. The share of the retirement market held in IRAs jumped from 31% to 38% in 2021, according to a recent report by Cerulli Associates. The research and consulting company expects that figure to rise further, to 41% percent by 2027, with most of the growth coming from rollovers.

When does it make sense to leave a 401(k) plan behind? That depends on its quality. A rollover can make sense if you are in a 401(k) plan with poor investment choices or high fees. A study by Morningstar found that average total costs paid by sponsors and participants varied widely; some plans charge as little as 0.1% against your assets, and some have total costs over 3%. These higher rates are usually found among small employers.

If you are not sure about your plan’s expense, send a written request to your employer’s human resources department, and ask for a written response to this question: “What are all the fees I’m paying, direct or indirect, on my account?” Ask the same question of any IRA provider that you consider.

Another benefit of rolling over is account consolidation. Many people wind up with a number of retirement accounts over the course of their working years as they move from job to job. Getting in the habit of rolling funds into a single, low-cost IRA as you move around is a good way to stay organized and avoid losing track of your money.

A rollover allows you to maintain the tax-deferred status of your assets without paying taxes or incurring penalties. The most efficient approach is a direct rollover, in which your 401(k) plan drafts a check or wire transfer made out to the new IRA custodian - not to you.

But avoiding high fees is critical. Research published last year by the Pew Charitable Trusts found that investors potentially can lose thousands of dollars over time owing to what might seem like small differences in total expenses - especially the cost gap between retail and institutional shares.

FOCUS ON THE FEES

Pew analyzed the difference between average institutional and retail share class expense ratios across all mutual funds that offered at least one institutional share class and one retail share class in 2019. The review found that annual expenses for median retail shares were 37% higher; for hybrid mutual funds holding both equities and bonds, the differences were larger - around 41%.

Pew concluded that these differences translated to more than $980 million in direct fees in a single year - and potentially tens of billions of dollars in losses from fees and forgone earnings over a 25-year investing horizon.

“What you want to be looking at is, are you going to be able to accomplish your investment objectives more effectively with the options in your plan, or outside in an IRA,” said Bob French, CFA, director of investment analysis at Retirement Researcher, which provides retirement guidance centered around academic research.

There is also a case to be made for staying in your 401(k) plan - especially if you work for a large employer. Big plans can negotiate low fees that will beat some IRAs. Another plus for sticking with your 401(k): it is subject to the fiduciary requirements of the Employee Retirement Income Security Act (ERISA), meaning plan sponsors must put the interests of account holders first.

This is not the case with IRAs. And most employer-sponsored retirement plans are protected from creditors under the ERISA standards. Non-ERISA accounts, such as traditional and Roth IRAs, do not enjoy those protections, although they are protected under federal bankruptcy law, should you file for bankruptcy.

There are signs that more retirees are sticking with their employer plans when they leave the workforce: 73% of the assets that were eligible for distribution that year stayed in their plans - up from 66.5% in 2019.

That points to growing efforts by employers to adopt retiree-friendly features in their retirement plans, especially more flexible ways to take regular drawdowns, according to Cerulli.

“Not that long ago, there really weren't good options for drawing down your money, other than a lump sum distribution to an IRA,” said David Kennedy, senior analyst for retirement at Cerulli. “But more employers want to maintain some sort of connection with their retired employees - and keeping more assets in the plan helps them get lower prices on the investment options they’re offering.”

Writing by Mark Miller Editing by Matthew Lewis

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