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Smart Asset: These Hidden 401(k) Rollover Fees Could Cost You Thousands

Many employees roll over their 401(k) plans into individual retirement accounts (IRAs) when they leave their jobs to avoid immediate taxes and continue growing their retirement savings. But a new study from The Pew Charitable Trusts shows that investor costs are generally higher in IRAs than in workplace plans and require more attention. Here are some of the hidden costs you should know and how to avoid them.

financial advisor could help you understand hidden fees in your retirement accounts and figure out which option is best for your savings.

The Hidden Cost of Rolling Over Your 401(k) to an IRA

Research from The Pew Charitable Trusts shows that when you move your 401(k) to an IRA, it can become costly. The small differences in fees between both accounts can cause investors to lose thousands in retirement savings.

That’s because institutional investors can harness their purchasing volume to access lower-fee shares. As a result, individual investors may pay higher fees for mutual funds than institutional investors, such as employer-based plans, do in a retirement account.

As an example, Pew examines a 65-year-old holding a hybrid 401(k) mutual fund portfolio with $250,000 in total savings who has elected to withdraw $1,000 monthly to supplement Social Security benefits for 25 years (until age 90). In a 401(k), the retiree would pay an annual fee of 0.46%. But if that account holder chooses an IRA, the fee would jump up to 0.65%

In this example, Pew estimated that over 25 years, the 401(k) account holder would have $217,553 in retirement savings, with $27,233 in total fees. But if that money had been rolled over to an IRA, the account holder would have saved $197,040 over the same time period and incurred a total of $37,091 in fees.

The difference in annual fees between a mutual fund held in a 401(k) and an IRA is 0.19 percentage points. But while this percentage difference could look small on the surface, that difference over 25 years adds up to $20,513.

Retirement savers should note that rolling over to an IRA does not guarantee that you will have to pay a higher fee. But it’s important to know what types of fees will be associated with an IRA to protect your savings.

What Are 401(k) Rollovers?

SmartAsset: These Hidden 401(k) Rollover Fees Could Cost You Thousands

There are multiple ways to save for retirement, and 401(k) rollovers are an important part of the process. A 401(k) rollover typically occurs when you leave an employer that you have an account with and transfer your savings to a new 401(k) account with another employer.

If your new employer doesn’t have 401(k) options, or you don’t like the new employer’s offerings, you can also choose to keep your account with your old job. Though in some cases, when the balance is too small, the employer may elect to cut you a check for the total. In that case, you will have 60 days to roll that amount over into an IRA or pay taxes on the distribution.

When you choose to roll over your 401(k), it will still need to happen within 60-day period to avoid dealing with a taxable distribution. The same grace period will apply to the 10% early withdrawal penalty if you are under the age of 59 1/2.

If you are considering a 401(k) rollover, there are four common options available:

  • Roll over your assets to an IRA or convert them to a Roth IRA
  • Keep your 401(k) as it is with your old job
  • Move your 401(k) into your new employer’s plan
  • Cash out your 401(k)

Additionally, a Roth 401(k) can be rolled over to a Roth IRA.

How to Execute a Rollover

When you’re ready to roll the money over, there are two ways to handle your cash: direct rollover or indirect rollover. Let’s compare the key differences:

Direct rollover: This occurs when your money is electronically transferred from one account to another. The trustee from your old plan will help you distribute the funds in your account to your new plan administrator.

If this process finishes within 60 days, your retirement funds will remain untaxed and unpenalized. If it isn’t finished within 60 days, the money in your account could be treated as a taxable distribution.

Indirect rollover: With an indirect rollover, you’re requesting the employer that holds your first retirement account to send you a check for the money you want to distribute. Then, it’s your responsibility to put it in your new retirement account.

But just like the direct rollover, you have 60 days to transfer your money before the IRS could treat it as a taxable distribution. Additionally, if you are under the age of 59 1/2, the IRS requires that you have 60 days to make a deposit or you may also have to pay a 10% early withdrawal penalty.

How to Keep Hidden Fees Slashing Your Savings After a Rollover

These Hidden 401(k) Rollover Fees Could Cost You Thousands

One of the benefits that you will have when rolling over a 401(k) plan into an IRA is that you may have a larger investment selection in an IRA. These could include individual stocks, bonds, mutual funds, certificates of deposit (CDs) and cash. Whereas a 401(k) will typically narrow your selection to a variety of mutual funds that include target-date mutual funds and stable value funds, as well as stock and bonds.

No matter your selection, it’s important to look out for investments that have equal or lower expenses than the ones you had in your 401(k). This will help you avoid incurring higher costs.

If you don’t find any options outside your 401(k), you could elect to leave it with your former employer until you figure out the best option for your retirement. Though setting it and forgetting it will not ensure that you will get the best value for your money. And you may also incur hidden fees that will continue eating into your savings.

Bottom Line

Many account holders aren’t aware of the hidden costs in their retirement plans. While a 401(k) rollover into an IRA can seem like a good option to avoid immediate taxes and continue growing your retirement savings when leaving a job, you should be aware of how much you could be paying in additional fees. A small difference in fees can add up to thousands of dollars in savings over time.

Tips for a Financially Successful Retirement

  • Planning for retirement can be quite an undertaking. Many of us aren’t equipped to handle it alone. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • Having a retirement age in mind can help you plan out your savings. You want to make sure you’re saving at the right rate to support yourself in the future. And that might require taking advantage of your employer’s 401(k) matching program. It’s essentially money already owed to you that can make a difference in your long-term savings.

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