Rollover IRAs: Good Idea In General, But What About A Small 401k?

If you leave your job and have a 401k or 403b left behind, the common advice is to roll it over into a Rollover IRA. There are several benefits to doing so, but here are the biggies:

  1. You maintain the tax-deferred status of the investment. For a traditional 401k, you would still be subject to ordinary income tax upon withdrawal, but along the way it would continue to grow tax-free. If you took the money as a lump sum, you would be subject to both taxes and penalties right away (with specific exceptions).
  2. Increased flexibility in investments. Most 401k plans have relatively limited investment choices, but you can open up an IRA at a variety of places. You can the invest in individual stocks, different mutual funds, bonds, ETFs, annuities, or even just a bank certificate of deposit.
  3. Save money by paying less fees. Along the same vein, many 401ks contain mutual funds with relatively high expense ratios compared to what is available on the open market. Many would recommend switching to low-cost index funds.
  4. You can consolidate accounts. You can combine the Rollover IRA with your other IRAs of the same time (Roth or Traditional Pre-Tax). One less thing to manage.
  5. Estate Planning perks.With an IRA, you have the ability to create a “Stretch IRA”, where your child can inherit and IRA and have the distributions “stretched out” across their longer life expectancy. This allows for more time to tax-free growth.

But many of these perks get overshadowed when you have a small 401k balance. My wife has an old 401k with only $2,000 in it at Fidelity. She gets to choose from a variety of Fidelity funds, including their Spartan index funds with 0.10% expense ratios, all with no minimum investment requirements. In addition, I don’t believe she is being charged any sort of administrative fees. We haven’t rolled it over to an IRA because:

  • Lonely IRA. We have no Traditional-type IRAs to merge it with at this time. We’d just be left with a $2,000 IRA.
  • Flexibility? If we moved it to Vanguard with the rest of our IRAs, we would not meet the $3,000 minimum for most of the funds. The only fund we could buy would be the Vanguard STAR fund.
  • No money to be saved? At most brokers, paying a commission for every trade on only $2,000 would really eat into the balance. We could move it to Zecco, which has free trades but also a $30 annual IRA fee. We can do better staying put, although if our existing investment choices were worse, finding a low-cost brokerage and switching to buying ETFs might be an option.
  • Itty-bitty estate. Again for small balances, this isn’t much of a factor in my opinion. No kids, anyhow :)

We could also move it to her new 403b, but it also has less-than-ideal investment choices. For now, it seems like the best move is really to stay put at Fidelity until there is a better opportunity. However, I would agree that our situation is a relatively rare case.

Comments

  1. Why don’t you just invest it in the Vanguard IRA fund that you already own…You are not required to purchase a new fund.

  2. CiaranFromChance says:

    Hey there,

    I think in the overwhelming majority of cases it makes sense to rollover your company sponsored plans when you leave the company. More often then not, you can keep your maintenance costs down by moving your monies to a more cost effective B/D, in comparison to the old company plan.

    In a lot of these plans they nickel and dime you to death and in the case of a small account there can be significant erosion, although it doesn’t seem to be in your case.

    One last thought, starting Jan 1, 2008… you can now roll company sponsored plans 401(k)’s, 403(b)’s. 457(b)’s etc. directly into a Roth IRA. Where as before you had to first move it to a traditional IRA and then to a Roth.

    By eliminating the middleman, it’s that much easier to get your assets into a Roth IRA, something your wife may want to consider (if you guys are eligible ofcourse:)

  3. you could rollover the $2k into trowe IRA with minimum of $1k. Even then, you don’t need to have the minimum if you set up systematic contribution to an IRA for as little as $50/month.

    if the 401k manager maintains the 401k as if you still worked for the company, then there isn’t a real need to move it if the expense ratios are good. Often, management fees will no longer be paid by the company for former employees, which is a good reason for you to move your 401k into your current plan or into an IRA.

    As Sean stated, if you already have Vanguard IRAs, then you can add to the existing shares, which typically only require $100 for additional investments into your existing funds.

  4. You could always roll it over into a Roth IRA if you already have one.

  5. I currently have $7,000 in my 401k but I’ll be leaving the company soon into a new company that doesn’t offer the 401k (yet). I’ve been doing a little bit of research but am still confused as to rollover into an IRA or a Roth IRA?

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