Transitioning Our 401(k)s After We Retire

If you missed Monday’s post on how much the work world is speeding up, check it out. It’s our most research-heavy post yet, and will definitely reassure you that you’re not alone if you feel like you can never get caught up at work.

As we promised in our recent pre-retirement to do list post, we’re dedicating a whole post to the question of what we’ll do with our 401(k) accounts after we retire next year. And for our friends in other countries, while the direct intricacies of U.S. tax code are not applicable to you, a lot of the same principles apply universally. ;-)

For a lot of us retiring these days, especially those who don’t figure out the FIRE concept early in their 20s, 401(k)s are our single biggest holding of assets, and what we do with them can make a meaningful difference in how much money we’re able to take out of them down the road. This is something we’ve thought a lot about, and today we’re sharing our full thought process. Let’s go!

First, a quick backgrounder/refresher on our specific 401(k) situation. We (mostly Mr. ONL) were good about saving in our 401(k)s way before we figured out that early retirement was an option, and as a result, our 401(k)s have been at a level for about a year now where we can basically stop contributing to them and they’ll still provide all we expect to need once we hit age 60 (not for 20+ years). Hooray for compound interest!

We’re still maxing our 401(k)s because we’re able to, and we’re not sad about the tax deduction (high bracket + AMT = a painful combo), but we could also make a case for stopping, given that our 401(k)s combined still dwarf our other assets and we could use that money instead to build up our taxable accounts faster.  If we weren’t beyond ecstatic with our trajectory, we’d definitely consider making that change.

While lots of folks are very legitimately thinking of ways to access the tax-deferred funds like 401(k)s and non-Roth IRAs before 59 1/2, our plan is to try to leave that money alone as much as possible, to provide ourselves some padding for our older years, and allow us to increase our standard of living when we get to that point. Short version of the reason why: We want to be able to travel more comfortably then, we expect our health care costs to be higher, and we wouldn’t be sad to have more money to donate to good causes in our post-60 years. Shorter answer: We might want to be ballers again in our 70s.

So that’s our 401(k) situation at this point in time. Let’s talk about the future.

Considerations After Quitting

After leaving a company where you have a 401(k), there’s technically no need to do anything. You can usually leave it just as it is, and that’s apparently something a lot of people do, probably just because of the hassle and intimidation of trying to figure out a better plan. (That’s just my guess as to why.) Or, you can do a rollover into a new 401(k) at a new job, or — more likely for the FIRE crowd — do a rollover into an IRA at the financial institution of your choosing. You already know all of that, right? So did we, until we dug a little deeper. (Psst. There are a few legitimate reasons why you might actually leave that money in your employer plan as the best course of action. But only a few.)

When researching what to do with our 401(k)s after we pull the ripcord next year, three big factors rose to the top:

1. Cost
2. Control
3. Liability

We’ll get into each of these individually, but the questions we learned we needed to answer to determine our best course were: 1. What is the cost of having our 401(k) funds with a given institution? 2. Do we have full control over our funds with that institution? 3. Does the structuring of our accounts give us good liability protection?

It’s worth taking the time to get this right because there are no do-overs. Once you’ve rolled money over from your 401(k) into an IRA, you never get that option back.

Cost

It’s pretty well known at this point that most employer retirement plans are rife with high fees, but if you need more proof, watch this episode of Frontline that I have made every person I’m related to or have ever met watch. Or if you want the same information rehashed with jokes and swearing, you can watch John Oliver’s version instead.

Bottom line: You want to make sure you’re not invested long-term in accounts with high fees, including 401(k) management fees that many employers pay for you while you’re employed there but stop paying after you quit. Even seemingly low fees like 1 percent can make a tremendous difference in your returns over the course of many years or especially decades. Want to see this in action? Check out the $600,000 difference that one percentage point makes in our pretend retirement math scenarios. And that’s only over 30 years, not a whole lifetime!

Of course, the financial institutions that run 401(k)s and other mutual funds aren’t known for their transparency in making fees easy to figure out. If your plan prospectus doesn’t make things enormously clear, you can use a fee analyzer like the one at NerdWallet to figure out what you’re paying now, and then compare it to the low-cost option you’re considering.

Control

Another key factor in whether to keep your 401(k) with your employer or roll it over into the IRA of your choosing is whether your current option gives you full control over your assets and allows you to invest in the types of funds you want. For example, if your 401(k) invests in your (former) company’s stock, and you happen to like that stock, you may not have that same option at another brokerage in a non-401(k) account. Or, conversely, if you really want to invest in index funds but your employer’s 401(k) brokerage offers no such product, then you may want to move along.

Liability

Something that we’ve very rarely seen discussed in relation to retirement accounts is how they relate to liability against future claims. [BIG DISCLAIMER HERE: We aren’t lawyers. This isn’t legal advice. Verify any of this with your own attorney.] But how you convert your funds out of a 401(k) actually matters a lot in terms of whether someone could get their hands on that money in the future. (And we’re not just talking to hotel moguls who declare bankruptcy after overleveraging in Atlantic City. Plenty of people get sued over accidents or declare bankruptcy because of health care expenses. And of course we’re already assuming that you have or will soon buy umbrella insurance as your first line of liability defense.)

A law called ERISA protects certain qualified retirement plans from legal proceedings against everyone except the federal government. As Investopedia puts it:

The Employee Retirement Income Security Act (ERISA) relates to federal protection of 401(k) and other employer-sponsored retirement accounts from creditors. The federal government ensures the safety of these accounts to protect retirement even in case of a lawsuit.

And thanks to the Bankruptcy Abuse Protection and Consumer Protection Act, many IRA funds are also protected from bankruptcy, but not necessarily from legal judgments. (And if you’re being sued by the IRS, then forget about it — they can get at all your funds.)

Though state laws vary, the consensus seems to be that accounts that originated as employer-sponsored retirement accounts (protected in full from creditors) can still maintain that status even post-rollover so long as they are held separately and maintained as their own standalone accounts.

Our Plan

Though we don’t plan to get sued or go bankrupt, it feels like a pretty serious no-brainer to maintain the assets currently held in 401(k)s as their own distinct accounts in the future, just in case. So when we do our rollovers, it will look like this:

If we have years in retirement when we earn enough that we can sock money away in an IRA, we’ll make sure we have separate accounts set up so there’s never any mixing or matching. Our 401(k) funds will (we hope) continue to grow once we roll them over, but we won’t add to them so that we kept their “employer-sponsored” nature intact for liability protection. (P.S. That’s another great reason not to convert all those funds over through backdoor Roths — once that stuff is modified or converted, it’s no longer protected, or at least you can’t ensure that it is.)

As for where we’ll put the money, we’re dedicated index investors, so we’ll give you three guesses. ;-) We can’t wait to get our 401(k) funds out of the greedy hands at Merrill Lynch and Fidelity, and into those of the more modestly compensated Vanguard. We’re not wed to Vanguard for all eternity (index funds could become too big and defeat the whole purpose at some point, not that that’s likely), and will keep assessing our options over the years.

What’s Your Plan?

For those of you who are on the road to early retirement, what do you plan to do with your 401(k) after you leave your career? And for those of you who’ve already left, any lessons learned that you can share?

What’s YSave

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