Should My Money Stay or Go? Employer 401(k) vs. IRA Rollover

We have all seen the ads from banks, discount brokers, mutual funds companies and insurers touting the benefits of rolling over your defined contribution plan balance to an IRA. Now a new contender for your plan assets is in the ring. Citing features such as low fees, access to institutional funds and the value of fiduciary oversight, employers are now encouraging participants to leave their money in their DC plan — even after leaving the company.

The choice: Stick with your employer-based retirement savings plan or shift to an IRA? Here are some tips for deciding which is the better option for you:

Evaluating plan features

Fees

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A frequently made point to keeping your balances in an employer plan is that due to the large pools of assets, they can offer funds with lower investment fees than the versions available to retail investors. What is frequently left out of the discussion is that employer plans typically assess a separate record-keeping charge, either as a percentage of plan assets or as a flat fee. You need to compare the total costs — including both administrative and investment fees — to determine the less expensive choice.

Example: An employee has invested $100,000 through their employer plan in a fund tracking the performance of the S&P 500 index, Vanguard Institutional Index Plus Shares (ticker: VIIIX). The fund has a 0.02% gross expense ratio. In addition, the plan has an annual $40 record-keeping fee. The participant terminates employment and can do an IRA rollover to the Schwab® S&P 500 Index Fund (ticker: SWPPX). The IRA rollover account doesn’t carry any annual fees.

Here is a cost comparison:

Even though the employer plan shares have the same expense ratio as the retail alternative, the rollover IRA will always have lower annual expenses due to the lack of an annual account fee.

In doing this analysis, you also need to factor in other potential fees — such as annual account charges and commissions for a brokerage account, withdrawal charges, processing a domestic relations order — that may be assessed by your employer plan compared to a rollover IRA account.

Institutional funds

Compared to a pool of retail assets, employer-sponsored retirement plans have unique attributes, such as more investable assets and longer time horizons, which allow investment companies to offer customized products (i.e., institutional funds) not available to regular investors. But simply being offered institutional funds doesn’t mean it’s worth keeping your money in an employer plan without evaluating their specific benefits. Here is how you can evaluate some of the frequently cited advantages:

1. Lower fees: As referenced above, many institutional funds are simply lower-cost versions of retail funds as employer plans can get better pricing due to their large pool of assets. But you must examine a plan’s total administrative and investment fees to see if this really provides an advantage.
2. Unique portfolios: Particularly in the largest plans, the fiduciaries will work with an investment manager to customize a fund for use by participants. One example is customized target date funds. An investment manager will create a bespoke portfolio for the plan with greater manager diversification, lower expenses and the goal of enhanced returns using a plan’s core fund lineup compared to the mutual funds offered by larger providers, such as Vanguard, Fidelity and Blackrock. Of course, you must evaluate the long-term performance history (as well as the cost) of any fund against alternatives available from your IRA provider. And you must balance any institutional fund offering against the fact that an IRA can be invested in a wide range of financial assets while an employer plan will have a closed menu of core investment options. Even plans with a brokerage window will typically only allow additional mutual fund purchases; not the broader range of financial products available through an IRA.
3. Stable principal funds: One type of institutional fund that is truly unique to defined contribution plans is the stable principal asset class. Also known as stable value funds or fixed accounts, these funds offer intermediate bond returns with a guarantee of the principal invested (assuming the creditworthiness of the guarantor). And while certificates of deposit offer similar returns, they carry early withdrawal penalties, while stable principal funds typically have no withdrawal restrictions.

Fiduciary oversight

The core obligation of a fiduciary to an employer-sponsored retirement plan is to carry out his or her duties solely in the interest of plan participants, including ensuring plan expenses are reasonable and selecting a diversified menu of investment options to minimize risk of significant losses.

There has been a lot of talk recently about “fiduciary” services. What exactly does this mean to you? And how do you compare this to services outside the Plan? Some ideas below:

• Reasonable expenses are judged based on marketplace standards for your Plan compared to 401(k) plans with similar assets and participants, not to IRAs. So, you may be paying “reasonable” 401(k) fees that are still far higher than the costs of a comparable IRA vehicle.
• As for investments, the plan sponsor in their role as 401(k) fiduciary is responsible for selecting and monitoring the core fund menu, not making individual investment recommendations for your account. There are similar services also available outside the Plan: for example, you can obtain fund recommendations for your IRA using the evaluation tools available on most investing platforms (e.g., Schwab Mutual Fund OneSource Select List®) or from third-party services, such as Morningstar.
• If you want a third-party fiduciary to make investment decisions on your behalf, many plans offer a technology enabled service (commonly referred to as a managed account) where for an additional fee you can delegate investment management of your account. These services initially enjoyed a fee advantage compared to fiduciary advisers outside the Plan. But with the rise of so-called “robo-advisers,” such as Betterment and Wealthfront, there are now cost competitive fiduciary advisory tools for your IRA as well.

There is undoubtedly some value to a plan’s fiduciary oversight, particularly if you are uncomfortable investigating alternatives. But with a little research, it is possible to identify comparable services outside the Plan as well.

Other features

The rollover IRA vs. qualified plan discussion frequently omits differences in these tax-deferred accounts, which may be relevant to some participants. These include:

Hacking your rollover decision

We are all looking for life hacks: a trick, shortcut, skill or novelty method that increases productivity and efficiency. Here are a few ideas from industry insiders on how to hack your rollover decision:

Age 59.5 withdrawals

Most people don’t know you can start rolling over your account at age 59.5, even if you are still employed by the plan’s sponsor. So, if you find a lower-cost IRA alternative to your current plan, you can roll over your balances while continuing to contribute and receive matching contributions.

Partial withdrawals

If your plan permits it, it may make sense to only roll over a portion of your account while exploiting certain 401(k) benefits with the remaining balance. For instance, if you want to allocate some of your portfolio to a stable value fund unavailable outside the Plan, withdraw the other assets and keep the remaining balances in that fund. Alternatively, if you are continuing repayments on a plan loan even after terminating employment, your loan may be defaulted if you request a lump sum distribution. But you can roll over a portion of your account while continuing repayments.

State Income Tax Exclusion

Many states exclude some, and in a few cases all, of any retirement account distribution from state income tax. But not all states treat distributions from 401(k) plans and IRAs equally. For example, both Maryland and Rhode Island only apply their state income tax exclusion to 401(k) distributions but not rollover IRA withdrawals.

These laws are complex and subject to frequent change, so you should check your state’s laws and factor in any additional state tax as part of the rollover decision-making process.

Conclusion

Behavioral science has taught us the power of defaults, such as automatic enrollment, when people are faced with difficult discussions. If your plan’s default is to retain your account balance, that may seem attractive — particularly when sponsors are emphasizing their plan’s benefits. But given the consequences, don’t just stand there. Instead, use the points above to make an informed decision to stay or go.

*Both Qualified Plan and IRA assets are protected from creditors during bankruptcy proceedings. Alternatively, assets can be seized under a qualified domestic relations or medical child support order or by the federal government for back taxes or criminal/civil penalties.