As individuals advance in their careers and start new professional roles at different companies, they may find themselves with several different retirement accounts. Managing all of these accounts can get very confusing. As a result, people often fail to optimize their accounts.
Furthermore, keeping several accounts open can prove inefficient, especially when it comes to rebalancing investments as the market changes. Ultimately, these issues can become a serious impediment to meeting retirement goals.
However, individuals do generally have the option of consolidating their retirement accounts. Importantly, there are a number of different types of retirement accounts and the rules for combining them are different. The IRS has detailed charts outlining consolidation options depending on the types of accounts that someone currently has.
Rollovers and conversions
Often, workers have multiple 401(k)s or 403(b)s through former employers. The funds in these accounts can often be rolled into the plan through the current employer provided that it accepts incoming rollovers.
Individuals can also roll these accounts over into an IRA with an investment provider that they choose. Sometimes, people have multiple IRAs, often because they opened them to accept rollovers. These accounts can also be combined into a single IRA or rolled over into a current 401(k) or 403(b).
However, traditional and Roth IRAs cannot be combined without going through a conversion process, which will involve paying associated taxes. Ultimately, individuals can roll everything into a single employee-sponsored plan or maintain one or more IRAs alongside it.
While it may seem like it makes the most sense to consolidate into as few accounts as possible, this does not always prove the best option. Some key points to consider when thinking about consolidation include:
1. Account fees
It is important to note that 401(k)s and IRAs can come with various management and administrative fees that can reduce the returns coming from these accounts. Before consolidating, individuals should investigate the fees associated with all of the accounts in question.
Ideally, everything can be rolled into an account that charges no or only minimal fees. Unfortunately, this is not always possible, especially if the plan through the current employee comes with significant costs. In this situation, it may make the most sense to roll the funds from older plans into an IRA with a provider that does not charge fees and maintaining two accounts.
However, there is also the question of convenience. Sometimes, it makes sense to consolidate into a single account and pay a little bit more in fees for the ease of managing everything in one place. Ultimately, this is a personal judgment call.
2. Creditor protection
Something that many people do not always take into consideration when consolidating retirement plans is creditor protection. In the event of bankruptcy, different types of retirement accounts come with different levels of protection for funds accumulated.
In general, employer plans offer complete creditor protection, while IRAs have more limited protections. However, the exact laws vary from state to state. This means it is generally worthwhile for individuals to investigate the situation, especially if they have significant savings in these accounts.
Sometimes, it makes sense to maintain an older employer-sponsored plan to retain the protection. While no one want to think about the possibility of future bankruptcy, it is always important to protect investments from every angle possible.
3. Investment options
When preparing for retirement, it is important to optimize the performance of retirement plans. This is accomplished by maximizing the amount of money in the best investment options available.
Sometimes, getting access to those best options means finding a new IRA or rolling older accounts into the plan with the current employer. Other times, it actually makes the most sense to keep multiple accounts open to take advantage of different investments.
Since individuals can find their own IRA, the investment options are somewhat unlimited, especially if they are not happy with the options offered by their current providers. Because this question can get so complicated, it may make sense to talk to a retirement expert for professional advice.
Investment options also need to be weighed against fees. At times, it can make sense to pay a little more in fees for access to better investment options.
4. Current and future income
As people think about consolidating their retirement plans, they should also consider the amount of money they currently make and what their salary will likely look like in the future. When people start to make more money, their retirement savings strategies often change. This can affect the optimal approach to consolidation.
For example, there are income limits to be eligible to contribute to a Roth IRA. In this case, individuals may want to put their savings in a traditional IRA and then convert it to a Roth IRA for the tax benefits. This is sometimes referred to as a “Backdoor Roth IRA” strategy.
To avoid paying immediate taxes when implementing this strategy, individuals need to avoid having money in a traditional IRA. This means that individuals will need to roll any traditional IRAs into a current employer plan or avoid rolling old employer plans into a traditional IRA from the beginning.