Enrolling in a 401(k) has never been easier, now that about two-thirds of large employers automatically sign up new employees in their workplace retirement plans. And thanks to the growth of set-it-and-forget-it target-date funds, investing the contributions to your 401(k) is a lot easier, too.
But if you leave your job or retire, you’ll need to make some important decisions about the future of your 401(k) plan. You’ll also get a lot of advice about how to invest the money, particularly from financial institutions that offer rollover IRAs
Rolling over your 401(k) to an IRA could provide you with more investment options than your former employer’s 401(k) plan had. It could also give you more control of your account, particularly once you retire. If you’ve worked for several different employers, rolling over your orphan 401(k) plans into an IRA also provides a way to consolidate your savings.
But your retirement security could be jeopardized if you roll over your funds into an IRA that charges high fees for subpar investments. And most workers don’t realize that IRA providers are not subject to the same investor protections that cover their 401(k) plans—a situation the Biden administration wants to change.
In late 2023, the U.S. Department of Labor proposed extending the fiduciary standard, which requires providers to act in their clients’ best interest, to financial advisers, brokers and insurance agents that offer rollover IRAs. Under the 1974 Employee Retirement Income Security Act (ERISA), employers that manage 401(k) plans must adhere to the fiduciary standard, but that protection doesn’t extend to recommendations for 401(k) rollovers. This one-time advice “is often the most important advice the retirement investor will ever receive and affects roughly 5 million savers per year who are rolling their money out of 401(k)s and into IRAs,” the Biden administration said in a statement. Biden has likened the costs imposed by some IRA providers to the “junk fees” charged by resorts, concertticket sellers and others, which the administration has also targeted.
Advisers who already comply with the fiduciary standard applaud the proposal. The National Association of Personal Financial Advisors, which represents fee-only advisers— those who receive no commissions for recommending products or services—call it “a major step forward to update and strengthen the fiduciary standard of care for the millions of hard-working Americans with retirement plans.” Opponents of the measure say the rule change would make it more difficult for low- and moderate-income savers to get financial advice. Critics of the proposal also note that previous efforts to extend the fiduciary standard have been struck down in court.
What to do now.
Even if this proposal survives a court challenge, it would likely be months before it takes effect. In the meantime, there are steps you can take to protect your savings:
Let your 401(k) funds sit with your former employer.
If your former employer’s plan offers strong investment options and reasonable fees, you may opt to keep your money there. If you have a balance of at least $7,000 in your former employer’s 401(k) plan, the employer is required to allow you to leave it where it is.
Leaving your funds with your former employer is also a good idea if you’re planning to retire early. In general, you must pay a 10% earlywithdrawal penalty if you take money out of your IRA or 401(k) before you’re 59½. There is, however, an important exception for 401(k) plans: Workers who leave their jobs in the calendar year they turn 55 or later can take penalty-free withdrawals from that employer’s 401(k) plan. But if you roll that money into an IRA, you’ll have to wait until you’re 59½ to avoid the penalty unless you qualify for one of a handful of exceptions. Keep in mind that you’ll still have to pay taxes on the withdrawals.
Roll the funds into your new employer’s 401(k) plan.
This strategy may make sense if your new employer’s plan offers low fees and attractive investment options. You may also want to keep your savings in a 401(k) plan if you intend to work past age 73. Ordinarily, you must take required minimum distributions from your IRAs and 401(k) plans starting in the year you turn 73 (the age when RMDs begin will increase to 75 in 2033). But if you’re still working at age 73, most plans will allow you to postpone RMDs until April 1 of the year after you stop working. If your plan allows you to roll over money from a former employer’s plan, you can protect those assets from RMDs until you stop working.
Transfer the funds to an IRA with low fees and good investment choices.
If you’ve changed jobs several times, you may have multiple orphaned 401(k) plans holding a smorgasbord of investments that may not suit your age and tolerance for risk. In that case, it can make sense to consolidate all of your old 401(k) plans in an IRA. And once you retire, having your assets in an IRA could give you more flexibility when it comes to taking withdrawals. Although many large 401(k) plans allow retired participants to take regularly scheduled withdrawals, some are less flexible. While many 401(k) plans offer institutional-class funds that charge lower fees than their retail counterparts, you’re limited to the plan’s options, says Christie Whitney, director of financial planning for Rebalance IRA, which provides fiduciary-standard financial advice to individuals who want to roll over their 401(k) plans.
While 401(k) plans have improved in the past 10 to 15 years in terms of portfolio diversification and costs, “you’re still beholden to whatever your company’s plan is offering,” Whitney says. “With a rollover, you’re open to the whole world of investment options.”