The average baby boomer has worked for six different employers over the course of their career, not counting jobs before age 24, according to the Bureau of Labor Statistics. This creates opportunities for retirement savings to be lost or forgotten.
Even if you’ve kept track of all your accounts, having too many of them complicates retirement planning unnecessarily. It means more companies to contact if you move or want to change beneficiaries, and more rules for you to follow — or risk hefty penalties for getting any of them wrong. This is particularly important once you turn 72 and must begin taking required minimum distributions. A missed RMD is hit with a 50% penalty on the amount that should have been withdrawn.
Consolidating accounts give you the ability to organize and manage your investments better, with the potential to save on fees and taxes. Also being aware of how much you have can help you manage your portfolio and evaluate your current financial goals.
The Pinch to Your Portfolio
Leaving 401(k) savings with a former employer can also take a bigger bite out of your investment portfolio. Although a former employer must let you keep the money in the 401(k) if the balance exceeds $5,000, the company can force accounts under that limit into a rollover IRA invested so conservatively that annual fees can quickly erode the value. A Government Accountability Office study of forced-transfer IRAs found that annual fees combined with low investment returns could exhaust all the assets in an IRA worth $1,000 in just nine years.
That’s because a typical retirement savings plan from an employer layers additional management fees on top of those charged by mutual funds. A different GAO report found that 45% of plan participants couldn’t determine the cost of their investment fee based on plan disclosures, and 41% incorrectly believed they didn’t pay fees.
By contrast, if you open an IRA with a brokerage or mutual fund company, you likely will only pay the fees from the specific investments you choose.
One downside of consolidating accounts is that you can lose access to commission-free trading or a specific investment in your 401(k) that only institutions can purchase.
Special Exceptions
You may also want to postpone consolidating accounts if you’re in your 50s and your 401(k) plan allows partial withdrawals that you might want to tap. The pandemic and Great Resignation are prompting many people to retire early, so many in fact that a new term has been coined, the Gray Resignation.
If you fall under this category, pay special attention to what you would lose by consolidating accounts. People between ages 55 and 59½ may be eligible for a special exception to the 10% early withdrawal penalty on plan distributions before age 59½. If you retire from a job during those years, you may take a tax-free distribution from the 401(k) of that employer only. If your plan allows partial withdrawals, you can even take a tax-free distribution in only the amount that you expect to need for living expenses between now and age 59½.
Another way to take distributions before the standard age is through the 72(t) rule, which allows you to take equal periodic payments between now and age 59½ without the 10% penalty, as long as that period is at least five years. Hire a financial professional to set this up, because if you miscalculate, the IRS can levy a penalty not just on the year that you messed up, but on all years, he says.
Where Simplification Counts Most
Once you’re retired, you can be more strategic about taking required minimum distributions if you roll over money from qualified retirement accounts into an IRA. This is particularly important when required minimum distributions kick in at age 72. RMDs, which both IRAs and 401(k)s have, are based on your life expectancy and the value of a retirement savings account, but the rules for satisfying the distributions are different depending on the type of account it is. If it’s a 401(k) or another employer’s retirement savings plan, distributions must be taken from each account separately. So, for example, if you have three 401(k)s, you must take an RMD from each one.
IRAs, on the other hand, offer more flexibility. If you have multiple IRAs, you can satisfy the RMDs for all IRAs by withdrawing money from one account. For example, if stocks are falling, you can avoid realizing those losses by taking your RMD from an IRA that holds bond investments or money market funds instead.
Rollover Rules That You Should Never Ignore
Whenever you’re consolidating qualified retirement savings plans or IRAs, check out the Internal Revenue Service’s rollover chart to be sure the move you want to make is allowed. If possible, request a direct rollover from one account to another so that the money bypasses you. Otherwise, you risk creating a taxable event if the check is made out and sent to you, with the money subject to 20% withholding and possibly a 10% penalty if the withdrawal is considered an early distribution. In that situation, the retirement plan withholds 20% of the withdrawn sum, and you would have up to 60 days to roll over the full amount, making up the 20% shortfall from other funds to avoid the penalty.
If you’re rolling over the money into another employer’s plan, take the time to read your plan documents carefully. The rules for rollovers will vary.
Depending on the circumstances, some accounts can’t be consolidated. For example, you can’t combine your IRA with your spouse’s while both of you are alive. Nor can you merge inherited IRAs that you received from two different people.
This commentary was originally posted by Katherine Reynolds Lewis – April 19, 2022
Source: The Price of Leaving 401(k) Money Behind | Kiplinger
**Disclaimer: This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.