401k, or not?

[MJtwelve]

Hello,

recently I changed employers, as I had worked with my previous employer for 4 years I had accumulated a small but decent sum in my 401K with their plan. Obviously as I terminated my service with them, I got a letter from vanguard (their provider) basically asking me what do I want to do with this money.. I can roll it over into my current company's 401k (which I don't have yet because my benefits haven't kicked in yet) or choose an IRA instead and send it there. I have heard good things about IRAs, such as you can withdraw money before retirement without getting heavily penalized? Does anyone know the other advantages of an IRA such as interest, etc?

What I am ideally looking for is to open up a brokerage account of sorts.. I didn't have this per say with my vanguard 401k through my employer but my money was heavily invested in stocks, which I would prefer to do, rather than have it just sit there and earn very small interest.

Thanks

[MakeAStash]

Though both 401k and IRA accounts have some protection against creditors, the 401k's protection is stronger. IRAs typically have more investment choices, including ones with lower expense ratios. If the amount is modest and you are not in danger of collection by a creditor, switching to the IRA sounds better to me.

[Petunia 100]

Hello,

recently I changed employers, as I had worked with my previous employer for 4 years I had accumulated a small but decent sum in my 401K with their plan. Obviously as I terminated my service with them, I got a letter from vanguard (their provider) basically asking me what do I want to do with this money.. I can roll it over into my current company's 401k (which I don't have yet because my benefits haven't kicked in yet) or choose an IRA instead and send it there. I have heard good things about IRAs, such as you can withdraw money before retirement without getting heavily penalized? Does anyone know the other advantages of an IRA such as interest, etc?

What I am ideally looking for is to open up a brokerage account of sorts.. I didn't have this per say with my vanguard 401k through my employer but my money was heavily invested in stocks, which I would prefer to do, rather than have it just sit there and earn very small interest.

Thanks

Hi MJtwelve,

If I were you, I would roll the money into an IRA at Vanguard and invest it in a Target Retirement Fund. You get broad exposure to the US stock market, foreign stock markets, and the US bond market, all in one fund with automatic re-balancing, and with a rock-bottom expense ratio.

Is this money currently in a traditional or a Roth 401k?

You are not allowed to withdraw money before age 59.5 without penalty from a traditional IRA unless you elect 72t rules. There are a few exceptions (such as 10k towards your first home purchase). However, withdrawals from a traditional IRA are always subject to tax.

You can withdraw your contributions (not earnings) from a Roth IRA at any time for any reason with no penalty and no tax.

[MJtwelve]

I heard from another friend they are hidden fees in IRAs and less interest?

And yes it's a traditional 401k (or was a traditional 401k) with my old employer.

[thesimplemoneyblog]

I'm not exactly sure what you are talking about with the 'hidden fees,' but you may be referring to the mutual fund expense ratios of the investments you select. However, you would have those same fees within the mutual funds in the 401k that you had. In fact, with the way 401k plans work, you might have higher fees in the 401k given that there are a lot of administrative fees and regulatory concerns within a 401k that are sometimes passed partially or wholly to the account owners. Depending on your state, the question of credit protection in a 401k versus an IRA isn't too much of a concern since a lot of the times a state may protect up to $1,000,000 in an IRA (though this depends). You do have a little more access to take money out of an IRA than the 401k, but you still have the same taxes and penalties that would apply upon withdrawal as petunia mentioned. In most instances you would pay both income taxes and penalties.

Some mutual funds have a transaction fee/commission, so be aware of that when you are researching funds. Many brokerage firms offer no monthly fee IRA accounts.

Be sure to 'roll over' the funds to an IRA instead of requesting a check/distribution (unless it is payable to 'Your Name IRA' from the account since you don't want to end up being taxed on the money as if you took it out.

[Petunia 100]

I heard from another friend they are hidden fees in IRAs and less interest?

And yes it's a traditional 401k (or was a traditional 401k) with my old employer.

The name "IRA" refers to the tax-advantaged status of the account. You can open an IRA with any bank or investment company you choose, and can put any investment inside of it you wish. Your rate of return is going to depend upon the performance of the investments you choose.

There is a cost to any investment. This is true if you hold the investment inside an IRA or if you don't. You absolutely want to pay attention to what your investment is costing you.

It is employer plans which are notorious for having hidden costs. Fortunately, due to recent law changes, the costs are now more transparent.

Since you have a traditional 401k, you may do a direct rollover to a traditional IRA. If you want to convert it to a Roth, you will need to pay income tax on the amount converted. I suggest you leave it in the traditional for now. Converting to a Roth is a separate decision.

[BuckyBadger]

I heard from another friend they are hidden fees in IRAs and less interest?

And yes it's a traditional 401k (or was a traditional 401k) with my old employer.

This statement makes me think you're a little confused about what 401ks and IRAs are exactly.

A 401k and an IRA are just buckets where you hold investments. The 401k or the IRA in and of itself has no fees (the fees are added on my the managers of the 401k or the IRA), nor would one have inherently less "interest" than another. They are just buckets where you put investments. What makes them so important is that the earnings (not interest) in those accounts are tax advantaged. That's why the government puts limits on how much money you can put in them.

And investments in the forms of stocks and bonds, which are what most people mean when they use the word "investment" with respect to retirement accounts, don't really earn "interest" like a bank account would. Stocks and bonds are market based, so they fluxuate with the market. Stocks and bonds have earnings or dividends. Interest implies (at least to me) something that is set and known -- like a savings account earning you 1% interest -- but your investments are going to go up and down with the market.

Some 401ks are excellent with great options and low fees. Some are not as great, but the tax benefits usually make even a bad 401k worth it for most people.

But your question is what to do with the 401k at your old company. How long until you would be able to start your 401k at your new company? Do you have other investments of any kind? How about a Roth IRA? Is your income level high enough that you can't contribute directly to a Roth? If so, are you planning on doing a backdoor Roth? If so, you don't want to have pre-tax money in a traditional IRA.

If all of this is too complicated, then rolling it into an IRA would probably be a fine choice. If it's a small amount, it probably won't make much of a difference even of you do get more involved in your investing in the future. I'd recommend putting it into a target date fund and leaving it alone.

You mentioned a "brokerage account" which scares me a little, since it implies to me that you want to do stock picking, which is a terrible idea. As I said previously, the simplest thing to do is probably put it in a target date fund in an IRA.

Good luck!

[MakeAStash]

The fees arise not from IRA vs. 401k but rather from your choice of investment. For example, for a given mutual fund, the fee will be the same whether you invest into it with IRA or 401k money. Early withdrawals from either IRA or 401k are subject to a penalty fee. You can avoid that penalty on 401k withdrawals by waiting until age 55, and for and the IRA until age 59.5. There are some other methods to withdraw early without penalties but they come with various restrictions.