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Options for Your 401(k)s and IRAs

Author: Jacob Jackson

It's easy to let your investments get away from you. You change jobs – sometimes a few times – you start an IRA to save more for retirement, and maybe you have other accounts for any number of good reasons.

The struggle is real: Multiple accounts with relatively low balances aren't just a management nightmare; they're not doing you much good because it's hard to diversify with low-balance accounts. What you want to do is combine them; it's called consolidation, if you want to sound like a financial guru.

Or maybe you're taking the opportunity to do something different with the accounts. Either way, there are plenty of options for them.

The Rollover

This is another financial term it's worth knowing. A rollover is when you take the money from one account and roll (transfer) it to another. Maybe you had a 401(k) with a small company where the mutual-fund options weren't all that good, but now you work for a larger company with a fantastic plan full of low-fee funds. You could roll your old 401(k) into your new one. You could also roll it into an IRA and open yourself up to a much wider range of investment products, such as individual stocks, bonds, ETFs​ and more.

Be careful. You don't want to take custody of the money, or the tax treatment gets messy. If you keep the money or roll it into a normal brokerage account, you could be on the hook for taxes and early withdrawal penalties. Have the custodian of the account directly transfer it to the new custodian. You never personally touch the funds and you avoid missing the 60-day transfer deadline for penalty-free fund shifting. (For more, see Retirement Plan Rollovers: Top Tips for Doing It Right.)

The Consolidation

A rollover and consolidation are basically the same thing, but if you have multiple 401(k)s you could consolidate (combine) all of them into your current employer's 401(k). Or, you could also take all the accounts that aren't part of your current firm and consolidate them into an IRA.

The Annuity

The problem with 401(k)s and IRAs is that they're tied to the financial markets. Who knows when the next financial meltdown will happen? What if you lose 30% of your account's value right before you retire, as so many did back in 2008?

An annuity can protect you from what is called market risk. It's simple: You give the insurance company (annuities are insurance products) your money, and the company gives it back to you later in your life as monthly payments. Kind of like a pension. There are numerous different types of annuities that work in various ways.

Frolian Rellora, chief investment officer at Catalina Asset Management, says, Annuities are most appropriate for individuals with no pensions or who have worries about outliving their money. The shift from defined benefit to defined contribution has made it difficult for some individuals to manage their money after retiring. Annuities can be a good solution for those seeking a reliable and predictable income stream during retirement. The increase in life expectancy has caused some investors to worry about outliving their savings. An annuity guarantees lifetime cash flow, which can remove the worry of going back to work after retiring.

But there are problems with annuities, according to Timothy Baker, founder and CEO of Wealthshape: I dislike annuities for virtually all of my clients for a couple of simple reasons. Transparency: The contracts are very complex with riders and fee structures that are often bundled together. Liquidity: Most come with a surrender charge if an annuity contract is ended prior to a 5 or 10-year period.... Although ongoing fee-based annuities exist, the overwhelming majority carry a commission, and from my perspective investors are far better served when their advisor isn't paid up front for years of future service.

Rellora agrees that these vehicles aren't for everybody. Investors with no investment plan should stay away from annuities. These products can be difficult to understand and often carry hefty penalties for withdrawals above the annual limit. They are also illiquid investments, so individuals with limited liquidity should consider other options. For more, see What Role Should Annuities Play in Your Retirement?

TIPS

If you're looking for a relatively high amount of security without inflation eating away at your money, consider Treasury inflation-protected securities, or TIPS. This is a type of Treasury that adjusts with inflation to guarantee the value of your money over time. You can purchase TIPS in a mutual fund or ETF, and some brokerages will purchase them for your IRA free of charge or for a fee. Ask your plan administrator if your 401(k) allows you to buy them. (For more, see Time to Favor TIPS?) Some advisors, however, believe that there are better ways to secure your money than with TIPS, including currencies, commodities, bond funds and real estate.

Self-Directed 401(k)

An increasing number of 401(k) plans have a self-directed option. This allows you or an advisor you trust to invest the funds as you would like, outside the limited fund options available in your regular 401(k). However, move forward with caution. If you don't have any experience with investing, your retirement money isn't the place to learn. If you decide to use the self-directed option, line up a financial advisor whom you trust. Check his or her credentials and strongly consider someone who works on a fee basis instead of on commission. For details, see How to Maximize Returns by Choosing the Self-Directed Option.

Roth or Traditional?

If you've read about retirement accounts, you might have heard the terms Roth and traditional. Basically, a Roth requires you to pay taxes now (there's no tax deduction when you invest money in one). By contrast, you are able to deduct money that you put into a traditional IRA or 401(k).

The other difference is what happens when you withdraw the money at retirement. If you believe that your tax rate will rise in the future, you might want a Roth, which allows you to withdraw money tax-free, including all the money your savings earned over the years. With a traditional IRA or 401(k), you pay taxes at the individual income-tax (not capital gains) rate when you withdraw funds. In addition, when you reach age 70½ you have to take Required Minimum Distributions from traditional IRAs and both types of 401(k). There are no RMDs with a Roth IRA. If you don't need the money, you can pass it whole to your heirs (they will need to make RMDs, however).

You can convert your traditional IRA or 401(k), if your company offers it, to a Roth account at any time. You don't have to convert all of the money at once. Conversions might trigger hefty income taxes for that year since you will owe income tax on any funds you convert to a Roth. (For more, see How a Roth IRA Works After Retirement and 401(k) Rollover: Pick Roth IRA or Traditional IRA.)

Some people create both a Roth and a traditional retirement account to hedge their portfolio. You could have a Roth IRA and a traditional 401(k), for example. It's what many savvy investors do.

The Bottom Line

As you age and your financial situation changes, you will likely have decisions to make about your retirement accounts. It's always best to have a financial advisor you trust to help you with the decision. Don't experiment with your vitally important retirement accounts.

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