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3 Reasons to Make This Rare Retirement Choice

Changing jobs is one of the most stressful things you'll ever have to do. In the midst of making new working relationships and handling tons of paperwork, one of the things that often slips through the cracks is what to do with the money you've saved in your former employer's retirement plan.

Financial companies have worked hard to urge people to take advantage of their right to roll over old 401(k) balances into IRAs. In fact, TD AMERITRADE (NYSE: AMTD  ) , E*Trade Financial (NASDAQ: ETFC  ) , and several other brokers routinely offer substantial incentives to potential clients who agree to roll over former-employer retirement money into new IRAs. Yet according to a study earlier this year from the Government Accountability Office, one often smarter choice gets far too little attention: rolling over old 401(k) money into your new employer's 401(k). Below, you'll find three reasons why a 401(k)-to-401(k) rollover might be your best bet.

1. You avoid a big tax hit.
One of the biggest mistakes people make when they leave a job is to take the money they've set aside in their company retirement plan and go on a spending spree. By doing so, they have to include the money they receive as taxable income, and if they're under the age of 59 and a half, they'll also have to pay a penalty of 10% of the amount they took. Even worse, even if you save and invest the money rather than spending it, you lose the advantages of tax deferral on the investment income it generates.

All rollovers, whether to an IRA or to a new employer's 401(k), avoid this bad result. By keeping the money within a tax-favored account, you maintain the full value of your retirement money and still reap the tax benefits so long as the money stays within the account.

2. You keep your retirement money in one place.
For many investors, keeping track of multiple retirement accounts is a major hassle. Yet given that the number of times we change jobs during our careers has increased greatly over generations of workers, you can end up with a patchwork of different rollover IRAs and 401(k) accounts if you're not diligent about consolidating them over time. Keeping accounts in one central location lets you more efficiently handle tasks like allocating your retirement assets across stocks, bonds, and other asset classes, without having to reconcile the different investment choices available in multiple plans.

3. You can cut costs.
Perhaps the best scenario in which to roll over old 401(k) money to a new employer's plan is when the new employer's 401(k) investment options are cheaper and better than you'll get in an IRA. The GAO study found that 401(k) plans often have access to lower-cost institutional share classes of mutual funds, with fees that are much lower than you'll find among the share classes available to most individual investors. For instance, fund companies Franklin Templeton (NYSE: BEN  ) and AllianceBernstein (NYSE: AB  ) have retirement-share classes available through 401(k) plans with no upfront sales charge, but the same shares offered to individuals can come with sales loads of up to 5.75%. If you like those funds and they're available in your new 401(k), then it makes far more sense to get access to the cheaper share option.

Make the right choice
The downside of rolling over old 401(k) money to a new employer's plan is that you lose the complete flexibility that a rollover IRA provides, as you're limited to the plan's investment options. In some cases, that's too high a price to pay for the convenience of having all your money in one place. But if your new plan has good low-cost investment options, then you should definitely consider the benefits of having the bulk of your retirement assets in one easy-to-manage location.

If you do choose an IRA or have a 401(k) that lets you invest in individual stocks, then your best investing approach is to choose great companies and stick with them for the long term. The Motley Fool's free report "3 Stocks That Will Help You Retire Rich" names stocks that could help you build long-term wealth and retire well, along with some winning wealth-building strategies that every investor should be aware of. Click here now to keep reading.


Read/Post Comments (4) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 29, 2013, at 4:35 PM, Timkatt wrote:

    I just had a look at my roll over account (with Vanguard) and compared it to my 401(k) luckily they both contain the vanguard mid-cap index. They have the same expense ratio.

  • Report this Comment On August 30, 2013, at 10:12 PM, bjgeissler wrote:

    Keep in mind that it may be most beneficial to just leave your money in the old employers 401K. It all depends on the plan, the investments, the costs, and many other factors. This is a good start to a much deeper discussion.

  • Report this Comment On August 31, 2013, at 12:18 AM, blharper326 wrote:

    While I agree that many 401k's have investment options with lower costs, there are many reasons that could also be good cause to rollover to the IRA instead of keeping it with the old employer or rolling it to the new:

    1. Some 401k's have high annual or quarterly maintenance fees for keeping your retirement savings with them.

    2. Most do not allow partial withdrawals, or if they do, they are limited (one withdrawal per calendar month or per calendar year).

    3. Some 401k's have restrictions on "in service withdrawals" for active participants.

    4. There is the lack of control in keeping certain investments because the plan may change the investment menu anytime they want, oftentimes without even notifying the participants.

    5. Old plans often move the entire plan to a new service provider, change the plan rules, and may have force out provisions.

    6. Many participants are not experienced with making good investment choices, and may hastily make unnecessary or foolish "fund transfers" due to lack of investment advice, which 401k service providers are not permitted to provide.

    There may be some reasons to stay in the old plan, like the "Age of 55 rule" (if applicable), or the presence of highly appreciated company stock in the plan (potential NUA opportunity)...but in the majority of cases I've seen, making the move to a rollover IRA makes more sense than staying in the old plan or rolling to the new.

  • Report this Comment On August 31, 2013, at 1:00 AM, WileECoyotee wrote:

    Here are a few more reasons why a 401k to 401k rollover may be the best move:

    1) Money in 401k's generally have greater protection from creditors and bankruptcy than money in IRAs.

    2) If the 401k is a traditional 401k, rolling it into a self directed traditional IRA prevents you from performing a back door Roth contribution. While pre-tax 401k money does not factor into the back door Roth, pre-tax (traditional) IRA money does. This does not apply if the 401k money is Roth-401k or if you already have a traditional IRA with pre-tax money preventing the back door Roth.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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