All 401K holders can opt to move from their previous employer’s 401K to their new employer’s plan, or they can opt to switch to an IRA when changing jobs. The same transition can be made when your retirement time arrives. Moving from one retirement plan to another in these two situations is called rolling over. In 2014, a Washington Post article highlighted that a significant number of retirees rolling over from their 401K to IRAs.
Statistics indicate that IRA accounts now hold more than $6.5 trillion, compared to the $5.9 trillion held by 401K. What could be causing the large migration of retirees to IRAs? The 401K plans are relatively safe retirement saving accounts because they offer economies of scale reducing the administrative costs and they practice frugal investment that reduces the risk.
However, the low administrative fees mean that most 401K holders do not get personalized financial advisers. Additionally, only those with a low-risk appetite will be satisfied with the investment options available in 401K plans.
Brokers are taking advantage of the 401K limitations and marketing IRAs to retirees and government employees. The most popular 401K, the Thrift Saving Plan has lost over forty-five percent of retirees. Unfortunately, a large number of those making the exodus lose a significant portion of the retirement savings in a few years.
Reasons why many retirees are rolling over to IRAs
1. Greater investment freedom
An IRA gives holders the opportunity to invest in exchange-traded funds, individual stocks, gold and other financial vehicles that 401K holders are restricted from exploring. The added freedom appeals to investors with a greater risk appetite.
2. Roth IRA
The Roth IRA is a retirement benefit plan that requires holders to pay taxes on the amount they deposit. However, the principle and profits accrued over the years are tax exempted. The Roth IRA is the only plan that allows you to deduct what is in your account when you reach the stipulated retirement age.
3. Broker incentives
Many brokers are marketing IRAs to 401K holders by offering incentives. Some benefits include cash incentives or a personal financial consultant.
Reasons not to rollover your 401K
a. Higher administrative costs
However, it is imperative to recognize that brokers are being paid a commission for every 401K rollover they can engineer. Sadly, most of the retirees realize that the IRAs offered to come with high administrative fees. In some cases, the fees are over 50 times that amount they were paying in the Thrift Saving Plan.
b. The risk of losing your retirement savings
Some brokers attract retirees into a “401k to Gold IRA rollover“. These IRAs are quite volatile, and you can easily lose 10-20 percent of your savings overnight, but in the long run a precious metals IRA will be a safe investment . Other risky IRAs promise high returns, but fail to mention the risk of losing your savings. IRA brokers are concerned with their company’s profitability as opposed to your portfolio. It is a lot easier to lose your retirement savings in an IRA.
c. Greater buying power and early benefits
Even though 401Ks do not have diverse investment options, they do have great bargaining buyer power. They can negotiate securities at much lower investment amounts than IRA account holders. Furthermore, only 401K retirement accounts can allow you to access your retirement savings at 55 with a small penalty.
d. Taxation and legal protection
Most of the earnings made in a 401K are considered capital gains and are taxed accordingly. The taxation rate is less than the income tax rate. This reduces the taxes you have to pay on your savings. Additionally, 401K holders are legally protected from creditor judgments like a child or spousal support, IRS tax liens and bankruptcy. IRAs only limit this protection to around $1 million.
Brokers are still offering lucrative incentives to retirees to ditch their 401Ks and join IRAs. However, they may fail to mention the risk associated with rolling over. If you are contemplating rolling over your 401K, conduct proper due diligence to ensure that administrative costs are reasonable and that the investment channels used are within your risk appetite.