Breaking Free from the 401(k) Trap

Breaking Free from the 401(k) Trap

401(k) plans are a great way to save money for retirement, but they don’t always have the best investment options available within the plan.  Employees are generally limited to a list of 10 or 12 mutual funds and are unable to choose funds not on the list.  This is especially problematic if the mutual funds in the plan are expensive or poorly managed.  We also find that many important asset categories are omitted from most 401(k) plans.

We rarely see options for real estate, commodities, foreign bonds, emerging markets stock and alternative strategies, for example.  Without these important categories, a 401(k) account can never be truly diversified.  We sometimes refer to this dilemma as the 401(k) trap, and it’s led many of our clients to explore the possibility of a tax free pre-retirement rollover, also known as an “in-service rollover,” to an Individual Retirement Account (IRA).

In an IRA, you have access to the entire universe of available mutual funds, and IRA accounts can be professionally managed in the same way as your other brokerage accounts.  We almost exclusively use institutional mutual funds, which carry much lower internal expenses than most funds found in 401(k) plans.  They’re also home to the industry’s best and brightest managers, in our view.

While the law fully permits in-service rollovers, some plans do not allow them.  Still 70% of all companies do allow them, and 89% of companies with 5,000 or more employees allow for in-service rollovers.  Even employees of the federal government, for example, are allowed a one-time in-service rollover. (Source: The Profit Sharing 401k Council of America, 2006 study of 1,000 firms)

The law allows rolling the following to an IRA as part of an in-service rollover:

–     Employer contributions, both profit sharing and matching contributions

–     Employee after-tax contributions (not Roth)

–     Employee pre-tax and Roth contributions only after the employee reaches age 59-1/2

Generally speaking, 401(k) plans are a great way to save money, but if you have limited investment options, you might find an in-service rollover to an IRA to be the best way to grow those savings.  If you’re interested in an in-service rollover, call your 401(k) plan administrator to see if it’s available for your plan.

Heath Hightower

Heath Hightower

As a CERTIFIED FINANCIAL PLANNER™ professional, Heath believes in giving solid, unbiased advice, and building relationships with clients that make a tangible, positive difference in their lives. He helps clients with all aspects of their financial lives, such as retirement planning, education planning, charitable giving, and investing.

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