Should You Keep Your Old 401(k)?

Posted on August 19th, 2009 in Investments, Newsletter Articles, Retirement Planning by wayne


I am often asked, “What should I do with a 401(k) or 403(b) retirement plan that I had with a former employer?”  Most former employees are allowed to keep their funds in the former employer’s plan or “roll over” their former plan assets into a new employer’s 401(k) plan.  However, for many people, the best option may be to roll over the retirement plan funds into an IRA.

Let’s look at some of the areas where having an Individual Retirement Account may be advantageous to continuing with your former employer’s retirement plan

Diversification – When you roll over your retirement plan assets to an IRA account with a discount broker such as Schwab, Fidelity or TD Ameritrade, your investment options become virtually unlimited.  For a small trading fee (typically under $10 per trade), you can have a well diversified portfolio consisting of Exchange Traded Funds (ETFs) and mutual funds.  Some retirement plans have such limited choices that providing adequate diversification is virtually impossible.  TIAA-CREF is an example of a large sponsor of retirement plans with such limited investment choices that it is difficult to produce a well diversified portfolio.

If your 401(k) has a good selection of mutual funds from Vanguard or Fidelity, you can roll your IRA over to a mutual fund account with Vanguard or Fidelity.  Not only will the funds in your 401(k) be available, the entire family of funds will be at your fingertips.

Fees – Fees are a significant contributor to the success or failure of an investment portfolio.  Every employer must disclose the retirement plan’s annual fees to the plan participants.  If your 401(k) plan is with a large employer, the 401(k) fees are likely fairly low.   If your employer is a small to medium sized companies, annual fees could be over 1%.  Combining this fee with the typical 1%+ annual operating cost for mutual funds in the plan, your plan’s total annual fees could be as high as 2-3%. 

At most discount brokerages, a well diversified, index-based ETF portfolio can be developed for approximately $100 in trading costs. Most index-based ETFs have annual operating costs of 0.25% or less.  Thus, the IRA option could have total annual fees that are over 2% less than the total fees of many 401(k) plans.

Investment Management – Larger employers often provide 401(k) investment advice to their employees.  However, when you leave the employer, you may find that this advice is no longer available.  Smaller employers typically offer both limited investment options and limited investment advice, with no advice available for past employees.

Fee only asset management is available to provide investment management advice to investors that have neither the time nor interest to manage their own portfolio.  Annual fees for fee only asset management may be as little as 0.75% of the assets under management.  If your asset management firm uses indexed based ETFs, the total annual costs of both management and fund operating expenses may be just 1% or less.  With this approach, you can have individualized professional investment management advice with total fees that are less than ½ of many 401(k) plans.

If you have well diversified investment options, a low cost retirement plan and the time and interest to personally manage your plan, there may be no need to roll it over to an IRA.  However, if diversification, fees or the investment management advice supplied by your former employer’s plan are not adequate, you will likely find that the IRA roll over option is the better approach.  

Saving Taxes While Paying for College

Posted on August 19th, 2009 in Educational Expenses, Newsletter Articles, Taxes by wayne


As your children (or grandchildren) head back to school, you may be wondering how you will ever afford their college education.  A four year education in a public university costs approximately $55,000 and a degree from a private university costs $132,000. 

In 15 years, these costs are estimated to rise to $316,000 for four years at a private university and $133,000 for a public university.  Since educational expenses are not tax deductible, with a combined state and federal tax bracket of 35%, the required before tax income to pay for these expenses is $486,000 for a private college and $205,000 for a public college.

Let’s look at two approaches to college savings where Uncle Sam can help pay these huge expenditures.

529 College Savings Plans – 520 College Savings Plans allow for a parent, grandparent or other family member to set up a plan for each child.  An individual may provide up to $13K annually or a couple can fund up to $26K annually for each child’s plan, using the annual gift tax exclusion.  A unique aspect of the 529 plan is the ability to pre-fund up to five years ($130K for a couple or $65K for an individual) when the plan is established.  

The investment growth in a 529 plan is not  taxed.  As long as the funds are eventually withdrawn for higher education expenses, associated with a college or graduate school, the 529 investment and its growth can be withdrawn tax free.

As an example, assume your daughter is just entering 1st grade.  Wishing to help pay for their granddaughter’s education, your parents put $100K into a 529 savings plan, with their granddaughter named as the beneficiary.  Assuming an 8% annual return on the 529 plan, when your daughter enters college, the 529 plan will have $252K available for college expenses.  If your combined federal and state tax bracket is 35%, the tax free withdrawal of 529 funds could save as much as $53K in income taxes.

529 plans offer great flexibility to the person who funds the plan.  In the example above, if the granddaughter decides to go to a public university and does not require the full amount remaining in her plan, the grandparents can change the beneficiary to another grandchild, who could then use the remaining 529 funds for their higher education.  The grandparents can even provide the remaining funds to grandnieces or grandnephews.

With a 529 plan, you must choose your investments from the investment options offered by the plan administrator.  However, the plan owner (funder) can change investment options once every 12 months.  If a better plan becomes available, you can even transfer the fund assets to a different plan as often as once per year. 

Coverdell Education Saving Accounts – Another way to fund educational expenses is through the Coverdell ESA.  Contributions to a Coverdell ESA can be made for any child, under the age of 18.  The maximum funding per child, regardless of the funding source, is $2,000 per year.  Thus, a family with five children can put aside a maximum of $10K per year into the Coverdell ESAs.

Similar to the 529 plans, all growth and income in a Coverdell ESA is never taxed, as long as the funds are withdrawn for qualified educational expenses.  Unlike the 529 College Savings plan, the Coverdell ESA funds can also be used for K-12 educational expenses.   Also, Coverdell ESAs can only be fully funded by individuals with annual income below $95K and couples with income below $190K.

If there are funds remaining in an ESA account, the Coverdell ESA funder may transfer funds from that ESA account into another ESA account as long as both account holders are under age 30.

If funds are not used for qualified educational expenses Coverdell ESAs and 529 plans have severe tax consequences.  In both cases, the income is taxed as ordinary income plus a 10% penalty amount is applied to the income.   However, the flexibility to transfer funds to other family members and the significant tax savings make both plans attractive to any family that is facing the significant costs of higher education.