Why workplace 401(k)-to-ira rollover could be a mistake

If you leave a job or retire, you’re often encouraged to roll over your 401(k) or other workplace retirement account into an individual retirement account. That might not be the right move.

Workplace plans have rules that can protect you from subpar investments and advisers who put their own interests ahead of yours. Workplace plans also may offer easier access to your money.

IRAS typically offer many more investment options, a fact heavily emphasized by the financial services companies that want your money. But just having more investment choices isn’t necessarily better.

Why the fiduciary standard matters

Most workplace retirement plans are covered under the Employee Retirement Income Security Act, which imposes a fiduciary duty on the people and companies overseeing the plans. Fiduciaries are required to operate solely in the interests of the participants and avoid conflicts of interest.

The U.S. Department of Labor is extending fiduciary coverage to IRA rollovers, recognizing that financial services providers often have a strong economic incentive to recommend them even when they’re not in an investor’s best interest. Dylan Bruce, financial services counsel for the nonprofit Consumer Federation of America, calls that “a very good development,” but it won’t happen overnight. Enforcement of the new rules will be rolled out in stages starting next year, Bruce says.

Workplace plans may cost less, offer more

IRAS are sometimes touted as being cheaper than 401(k)s on average, but often that’s not the case. Since 2000, the cost of equity funds inside 401(k) s has dropped substantially, according to the Investment Company Institute.

The average expense ratio for stock mutual funds in the U.S. in 2020 was 1.16 percent, while 401(k) investors paid about one-third that amount, or 0.39 percent, on average. Expense ratios are the annual fees charged for operating and administering the funds.

Fees make a big difference in how much your nest egg can grow. Let’s say you invest $20,000 in a fund with a 1.16 percent expense ratio that grows an average of 8 percent each year. After 40 years, you’d have about $282,000. With a 0.39 percent fee, your balance would be nearly $376,000, or one-third more.

Accessing your money can be harder with an IRA, as well. You can’t borrow money from an IRA for longer than 60 days, or it’s considered a taxable distribution. Any money you withdraw before age 59½ is typically penalized as well as taxed, although the penalty is waived for certain withdrawals, such as for higher education or a first-home purchase.

With 401(k)s, by contrast, you can begin withdrawing money at age 55 without penalties if you no longer work for the company offering the plan. If you transfer an old 401(k) account to a new employer’s plan, you typically can borrow up to half of your total vested balance or $50,000, whichever is less, and pay the money back over five years.

Furthermore, your 401(k) is also generally protected from creditors. Protection for IRAS varies based on state law.

When a rollover makes sense

Many people don’t want to leave money behind at their previous employer, and a rollover is a much better option than cashing out. A rollover also could be prudent if you don’t have access to a low-cost 401(k), you want to consolidate multiple retirement accounts, your investment options are too limited or the adviser recommending the rollover is a fiduciary (and willing to put that in writing).

It’s essential to investigate all your options, though, before deciding an IRA rollover is the right one.