By Mark Miller
CHICAGO Jan 9 Regulators are sending a clear warning: Beware the IRA rollover.
The Financial Industry Regulatory Authority (FINRA), which self-polices the brokerage industry, issued a regulatory notice late last month warning member firms against overselling clients on shifting retirement dollars from 401(k)s to individual retirement accounts when they retire or change jobs.
"Whether in written sales material or an oral marketing campaign, it would be false and misleading to imply that a retiree's only choice, or only sound choice, is to roll over her plan assets to an IRA sponsored by the broker-dealer," the notice states.
Likewise, a report last year by the U.S. Government Accountability Office found that plan providers often sell IRA rollovers to workers without laying out the alternatives.
The warnings come as the U.S. Department of Labor gears up to propose broad new rules later this year that would require brokers to act as fiduciaries, including when they advise clients on rollovers.
The financial services companies that administer 401(k)s have a huge economic incentive to encourage rollovers, since they generate transaction fees on trades and ongoing account fees. And it's big business. Households transferred $288 billion from workplace plans to IRAs in 2010, according to the most recent data from the Investment Company Institute (ICI).
That figure dwarfed the $12.8 billion in direct contributions that year - and the rollover numbers are expected to swell as boomer retirements accelerate. Last year, 49 percent of all IRAs contained rollover assets, ICI reports.
Rolling over your account to a new employer's plan or to an IRA can make sense. It's certainly a better option than cashing out, since that move sets back your retirement saving and subjects withdrawals to ordinary income taxes. Plus, if you haven't reached age 59 1/2, you'll pay a 10 percent penalty. But in some situations, you may be better off staying put.
If you're evaluating a rollover decision, here are critical questions to weigh.
- Will an IRA cost you more? Fees are one of the most important determinants of long-term portfolio performance, so it's important to compare expenses in the 401(k) you'd be leaving behind with those in the IRA. New 401(k) fee disclosure forms introduced last year make it easier to identify the costs levied on each mutual fund in your plan, expressed as an expense ratio. Sometimes, plans charge additional administrative fees; those must be disclosed in your plan's Summary Plan Description, which must be furnished to you on request by the plan sponsor.
If you're in a large 401(k) plan, chances are good that costs are reasonable. Brightscope, which tracks 401(k) plan performance, reports that fees levied in large 401(k) plans have been falling for several years; in 2012, the average total cost in plans with $1 billion or more was just 0.34 percent. (The measure includes all of a plan's investment and administrative costs.) And a recent Brightscope ranking of the 30 best 401(k)s found total plan costs averaging just 0.28 percent.
But the story can be far different in small 401(k) plans. Total costs in plans with $25 million or less in assets averaged 1.29 percent in 2011, according to the most recently available Brightscope data.
It's not difficult to keep costs down in an IRA, especially if you use low-cost passive index mutual funds or exchange-traded funds. For instance, the Vanguard 500 Index , which tracks the Standard & Poor's 500-stock index, has an expense ratio of just 0.17 percent. But many actively managed mutual funds have ratios well north of 1 percent.
"It's easy to look up a fund's ticker symbol and check the expense ratio," says Christine Benz, director of personal finance for Morningstar. "If it's higher than 1 percent for an equity fund, that's a high cost."
- Do I need guidance? Your 401(k) plan sponsor has a fiduciary responsibility to vet investment options - and the plan can serve as a sort of guardrail against bad investments.
"If you don't know what you're doing and go out and buy a risky social media fund in an IRA, you'd have been better off staying in the 401(k)," says Benz. "The investment lineups usually are plain vanilla, and investors can't do as much harm to themselves."
And a growing number of plans offer participants low-cost - or free - financial guidance from third-party services such as Financial Engines or GuidedChoice. The advice can add to your investment costs (typically no more than 50 basis points), but it's coming from the best type of planner: an independent adviser with the fiduciary responsibility to put client interests first.
- Simplify. If multiple 401(k) accounts are trailing you around from previous jobs, it makes sense to consolidate - either by rolling into your current 401(k), or to an IRA, if your current employer's plan isn't up to snuff. That makes it easier to manage asset allocation whenever you retire or required minimum distributions if you've reached age 70.5.
- Do I need more flexibility? If you're a self-directed investor with a wide-ranging appetite, an IRA offers a nearly limitless menu of choices. It's also the place to do Roth IRA conversions, although a growing number of 401(k) plans are offering in-plan conversion options.
So - stick or switch? Unfortunately, there's no one-size-fits-all answer. But the rising regulatory heat should encourage more retirement savers to take a careful look at the question, rather than fall for sales pitches.
"I give FINRA credit for looking at the issue, because some advisers do have incentives to get clients to make decisions that aren't in their best interest," says Benz. "But I'd hate to see people get the idea that an IRA isn't a good idea, because it often is the best route."