Archives for January 2008

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.

Okay, so I’ve decided upon an asset allocation plan. Now for my least favorite part – juggling and cramming all those asset classes into several different accounts. First, I’ll list my existing accounts, their estimated current balances, and my flexibility in investment options.

So I’ve got 7 asset classes to fit in 5 accounts. Below is a chart that shows the major asset classes sorted by tax efficiency:

Next, I combine my chosen 86% stocks/14% bonds with my asset allocation to find the breakdown below:

For example, with 40% of all stocks as US Large, I get 40% x 86% = 34.4% US Large over my entire portfolio. You might notice that I also sorted them in the tax-efficient order given above.

But in this case, I also need to consider the availability of low-cost index funds as well as placement, especially since all my money is already in tax-deferred accounts. My Roth IRAs are all with Vanguard with a wide variety of index choices, but my Traditional 401ks are limited to a few select index funds. After spending some time with a pencil, paper, and good eraser, here is the compromise I have worked out:

Roth IRA #1
$7,000 Vanguard Short-Term Treasury Fund (VFISX)
$3,000 Vanguard REIT Index Fund (VGSIX)
$8,500 Vanguard Small-Cap Value Index Fund (VISVX)
$8,500 Vanguard Emerging Markets Stock Index Fund (VEIEX)
$19,000 Vanguard Total Stock Market Index Fund (VTSMX)

Roth IRA #2
$7,000 Vanguard Inflation-Protected Securities Fund (VIPSX)
$6,000 Vanguard REIT Index Fund (VGSIX)

Traditional 401k #1
$23,000 Fidelity Spartan International Index Fund (FSIIX)

Traditional 403b #2
$14,500 Diversified [S&P 500 Index] Fund (DISFX)

Traditional 401k #3 (old job)
$1,000 Fidelity Spartan Total Market Index Fund (FSTMX)
$1,000 Fidelity Spartan International Index Fund (FSIIX)

On additional reason for this particular set up is to accommodate future growth. As the year progresses, I can continue to buy more shares of the largest asset classes (FSIIX and DISFX) in our 401ks. To retain the target asset allocation if things get out of whack, I can sell VTSMX in my Roth IRA and buy other funds as needed, with only a $3,000 minimum for most funds. I avoid any other low-balance fees at Vanguard by choosing electronic delivery of statements. In the future, I may switch my IRAs to an brokerage account to simply buy ETFs, but I don’t think that is necessary quite yet. I like the current simplicity and good service.

(By the way, I have such large Roth IRA balances because I did a Traditional-to-Roth conversion while our tax brackets were lower than they are now.)