Advertisement

Question

QUESTION: My husband changed jobs in 2006, leaving his 401(K) acct at his old company.There is a sizable amt involved. I know we can move this when we want. Obviously no money has been added by us to this account. He did start another 401(K) at his new company.

He also has a Roth IRA and a traditional IRA (that we no longer make contributions to).

My question(s)— if we ‘rollover’ the old company 401(K) can we keep it split up among different mutual funds (like it is now)(how to do this?) or does it all have to go to one Fund Family? Is this a big paperwork nightmare?

We are looking at ETFs for this money, due to lower costs than the annual fees charged by the funds. I know there will be commission paid to start, but over time this will be less than the fees charged now. Thinking of using one of the discount brokers for this.

What do you think? Have I asked the right questions? Suggestions, insights welcomed. Thank you

ANSWER: Hi Karen-

Good question, you’re hitting on a lot of good topics about retirement accounts.

Yes, after you leave a job you can rollover a 401k plan to an IRA, and your choice of investments is limited only by where you choose to open that IRA. You could open it at a mutual fund company like Vanguard or T.Rowe Price (or hundreds of others), and choose from their fund offerings. You could open it through a discount broker and buy stocks and ETFs. If the discount broker offers a mutual fund supermarket (as almost all of them do) you could buy mutual funds as well — some with trading fees, others without.

There are some special cases where you might not want to do an IRA rollover. I can’t cover them all here but some examples: if the 401k holds company stock, there’s a special tax trick you might want to make use of. If the 401k has a few really good investment alternatives, that you can’t get outside the plan (e.g. low-cost institutional funds), you might just keep the money there. Or, you might have a reason to transfer the money to the new-job 401k plan. perhaps you’d like to make use of the earlier retirement distribution date that is available for 401ks (it’s 55 for 401ks, vs 59 1/2 for IRAs). Or maybe you want the flexibility to borrow money from the 401k in the future — you can’t borrow from an IRA.

If none of the special cases apply, then it’s a matter of figuring out how you want to invest the money, choosing the best place to implement that, and opening a rollover IRA there. If you use ETFs, any discount broker would do, but keep an eye on the fees because many do nickel and dime you. Not just commissions, see if they charge for things you might want — paper vs. electronic statements, for example. A big one currently is money-market rates. You might plan to leave 5-10% of the account, say, in a money-market fund as a cash holding. At TD Ameritrade, one of the worst offenders at the moment, they’re currently (2/22/08) paying 0.1% on even a $30,000 money market balance in a Roth IRA. That’s not a typo. 1/10th of 1%, which is an insulting $1 per year per $1000 invested. In contrast the custodian I use for client accounts is paying about 4.5% at the moment. Forget about saving $2 on a trading commission, these are the things that can really add up.

RE: ETFs vs. funds. I use a lot of ETFs but I also use a lot of traditional mutual funds which make still make the most sense when transaction sizes are going to be smaller, and the trading costs of ETFs become significant. And that comes up quite a bit really. Think long-term with this, not just the initial purchase. Let’s say you’re rolling over $30,000 and of that, 10% is going to be invested in, I don’t know, a foreign stock mutual fund. That’s $3000. Imagine a year passes and that 10% allocation becomes 13% which you think is a little too much, and you want to pare it back to 10% again. With traditional (no load) mutual funds you’d probably be able to do that shift at no cost — if held through the mutual fund company it could be a fund-to-fund transfer done with one mouse click.

But here’s how you adjust your money if you hold ETFs. sell enough shares to equal that extra 3% of your foreign stock ETF, and pay a commission on that trade. Then use the proceeds to buy whatever the replacement is and pay another commission. Maybe that’s $10 each, for $20 total. No big deal? Well, maybe. but that might be $20 on a $900 trade, which is 2.2%. And this is just for one of your holdings. If you incur these kinds of costs at rebalancing, the small cost advantages of ETFs go away.

Also note that you’re going to have some slop in this transaction, you won’t be able to invest all your money. You can request a purchase of any specific amount of a mutual fund — $1000, $1003.22, $877.32 — that’s no problem. But with ETFs you’re buying shares at the current price. It’s an IRA so you don’t want to overshoot, there’s no way to add cash to the account. So let’s say you sell that foreign-stock ETF and it nets you $877.32. Now you want to invest $877.32 in another ETF. You’ll need to pick a share quantity that invests as close to that as possible, but you’re unlikely to hit it exactly. So with every trade you’ll probably have some cash that spits out, that won’t be invested (and if you’re at TDA it rots there earning 0.1%). I know, not a huge issue, but the cost advantage of ETFs is so small that these things can actually add up.

The trade-size issue comes up at distribution time too — you might be pulling a small amount from each of your investments every month, as monthly distributions. That’s a routine thing to set up with traditional mutual funds — $500 from here, $200 from here, $1000 from here. With ETFs, that becomes costly, to the point where you would never do that. (Of course, because this is an IRA where taxes from selling aren’t a concern, you could always sell off all your ETFs when you get to distribution phase, and move the money to mutual funds at that point.)

So to bottom-line it — yes, rollover is possible, choose the IRA custodian based on investments, and while ETFs may have cost advantages don’t rule out traditional mutual funds, which may be cheaper in the long run.

-Tad

QUESTION: Thank you for your prompt answer!

Would it make a difference if the amt we’re talking about was in the

$360000 range? None of the funds are institutional and right now it’s held by Vanguard. I like it’s diversity. I guess we were spooked about all the ‘fees’ and were told ETFs were the way to go.

Answer

Yes, it makes a difference, because your trade sizes are that much bigger for a $360k account, so trading commissions will be a smaller percentage of each trade.

You mention fees. but also that you’re at Vanguard. That’s the industry standard for low fees and you’d probably see only minor differences by moving to ETFs. As an example, look at some of the options for core holdings for index funds tracking the overall US stock market. Vanguard’s Total Stock Market Index mutual fund, ticker VTSMX, runs at annual expenses of 0.19% for the regular retail shares. The ETF version of that same fund, ticker VTI, runs for 0.07%. The iShare tracking the Russell 3000, ticker IWV, is 0.20%.

These all would be expected to track each other very closely but for this segment of the market VTI is the cheapest, though again you need to factor in transaction costs. The difference is probably big enough to bother switching to ETFs, if this core holding was a significant part of a 360k account and you currently hold VTSMX.

If you’re considering other ETFs that are very similar to your Vanguard funds, compare the costs one by one. But if you’re thinking about this just because of general commentary about cost advantages of ETFs over mutual funds realize that type of commentary isn’t really directed at a Vanguard mutual fund investor, who already has some of the lowest costs available. Really, it’s for the guy with a brokerage account, who might own actively managed mutual funds with expenses closer to the 1.4% or so average for annual expenses. Moving to iShares in the 0.2-0.3% range of annual expenses represents a big improvement in costs for that type of investor.

And a lot of that commentary is directed at clients of wirehouse brokerage firms, who would rarely if ever be directed towards Vanguard’s low-cost offerings. Index funds are kind of a novelty there, not so for a Vanguard customer.

Suggestion: call Vanguard and see what they recommend. keeping the 401k, rolling it over to an IRA with the same mutual funds, or rolling it over to an IRA and coverting some or all of them to Vanguard’s ETFs (assuming one is available for each). Then you can do your homework to plug in other ETFs from iShares and other ETF providers.

I doubt you’d see much cost advantage moving the account entirely from Vanguard, and buying ETFs through a brokerage account. But check it one-by-one for each fund you own and each ETF you’d buy instead.

And be careful of the new ETFs in these obscure and nutty indices, I think there’s a lot of nonsense out there in the ETF world and many of them will go away.

Last point — one advantage of a rollover IRA (over keeping an old 401k as a 401k) is that you’re able to convert the assets to a Roth IRA in years that makes sense, and you qualify for a conversion. Given that you have a substantial IRA I’m assuming that’s not going to be a factor, but you never know. Take a year’s sabbatical and the low income that year can make a Roth IRA conversion of part of your retirement savings feasible.

-Tad

Questioner’s Rating