October 2011: 401(k) Rollovers

Dear Clients and Friends,

The sun has finally come to San Francisco!  If you're not familiar with the pattern of seasons here in SF, we have finally entered our sunny and warm fall season.  It's a relief after our extremely cold and foggy "summer".  In addition to the wonderful weather, I have additional good news to report.  If you haven't already heard, my lovely wife Colleen is pregnant with our first child!  She is due October 18th and we couldn't be more excited!  We've been busily nesting, arranging, preparing and simplifying our home in preparation for the coming whirlwind of activity.

Speaking of whirlwinds, we are all dealing with the recent market turbulence.  Unfortunately, the political theater in the US, coupled with the ongoing Euro-zone crisis, continues to cause significant turmoil in the markets day-to-day with each new headline.  I addressed this in my last quarterly letter (click here, to see it again) and in the mid-quarter client update; so I'm not going to belabor it again in this letter.  But if you have any questions, or just want to talk, don't hesitate to reach out.

In addition to baby prep, I have been on-boarding several new clients which involved consolidating accounts and rolling over 401(k) accounts from previous employers.  Which leads me to the topic of my current letter...

Pros and Cons of Rolling a 401(k) to an IRA
(Or: To roll... or not to roll.)

Generally speaking, you cannot roll a 401(k) from you current employer to an IRA.  You can only roll over a 401(k) from a previous employer.  Many people these days have several older 401(k) accounts from previous employers floating around.  In that case, there are two rollover options:

1. Roll your old 401(k) into your new 401(k)
2. Roll your old 401(k) into an IRA

We'll look at some of the pros and cons of each.

Roll into your new 401(k):

Pros:

• Consolidation: Having your money in one bucket makes it easier to manage and track.
• Custom Investment Options:  Some 401(k) accounts have investment options which are not available outside a 401(k).  Stable value funds are one example of a product that is not offered outside a 401(k).
• Loans:  Your 401(k) account may offer loans.  Although I'm not a big fan of 401(k) loans, some people may view this as an advantage.  This is directly from the IRS website:  "Generally, if permitted by your plan, you may borrow up to 50% of your vested account balance up to a maximum of $50,000. The loan must be repaid within 5 years, unless the loan is used to buy your main home. The loan repayments must be made in substantially level payments, at least quarterly, over the life of the loan."
• Early Distribution Options: Your 401(k) may allow you to make a distribution earlier than the typical 59 1/2 age limit.  Again directly from the IRS website:  "Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55."

Cons:

• Cost: Many 401(k)s are loaded with high cost funds.  Although most 401(k)s don't levy direct fees on user accounts, the costs of the program are often covered through the expenses in the mutual funds offered.
• Limited choice: Many programs only offer a few choices for investments.  Sometimes the investment products are quite mediocre.  This can make it difficult to develop and maintain a quality investment strategy.

On the other hand, you can:

Roll over an old 401(k) into an IRA.

Pros:

• Consolidation:  Similar to above, you can house all of your non-401(k) accounts with one provider for simplicity and convenience.
• Roth Conversion: Now that conversion limits have been lifted, traditional IRAs can be converted into Roth IRAs.  Taxes need to be paid at conversion.
• Unlimited Investment Options: Most brokerage firms allow you access to virtually all products actively traded.  Some firms even offer low or no-cost trading for certain  products.
• Investment Strategy: Your consolidated view allows you to develop and implement a consistent investment plan.
• Advice: a rollover IRA can be the basis for working with a financial advisor or investment manager.  Most 401(k) programs don't offer individual advice.

Cons:

• No Loans:  Loans are not available from IRAs.  Nor can they be used as collateral for a personal loan.
• Early Withdraw Limits:  Withdrawing IRA proceeds before age 59 1/2 means you need to pay income taxes on the distribution AND a 10% early withdraw penalty.

Although this is not an exhaustive list of the pros and cons of 401(k)s and IRAs, it gives you a basic framework for deciding if rolling over a 401(k) is right for your situation.

At Bootstrap Capital, in many cases, I have found it appropriate to roll over old 401(k)s into an IRA.  This forms the basis of the investment management and financial planning process and allows the client to develop a personal plan that is not available to them from a traditional 401(k) plan.  If you have any questions about 401(k) rollovers, please don't hesitate to contact me.  And, as usual, if your friends and family have questions about rollovers, or any other financial issue, please don't hesitate to make an introduction or forward this letter.  We provide Financial Planning and Investment Management services and would be happy to talk with your acquaintances.  We will treat your friends and family with the same care and diligence that we treat you.

Thanks,

Brian McCann