To Rollover, or Not?

Why retirees should think twice before shifting 401(k) assets into an IRA.

See this year’s 401(k) Buyer’s Guide

Some 16.7 million baby boomers will retire by 2010. As they dial up their hearing aids to groove to their old Beatles CDs, many will be drawing income from a combination of Social Security, traditional pensions, and one or more 401(k) savings plans. As they juggle those sources of income, they may want to leave “Let It Be” on repeat play. Many employees cycle out of their 401(k) plans and into an individual retirement account, believing that it simplifies their personal finances.

But a rollover into an IRA may not be the right choice, for several reasons. Lower plan-service costs for 401(k)s; the sponsor’s fiduciary obligations; and the ability, courtesy of last year’s Pension Protection Act, to continue 401(k) benefits to spouses who outlive the primary beneficiary, make 401(k)s more appealing. (Prior practice required spouses to cash out upon the retiree’s death.) The legislation also permits plan sponsors to offer advice to employees and retirees about their investment choices.

Companies like IBM have latched onto this aspect of the pension act. In March, Big Blue announced a multimillion-dollar personal-finance and educational program called IBM MoneySmart to help its U.S. employees better plan their retirements; in January, the company will freeze its traditional pension plan and switch entirely to a 401(k) plan. “Employees need to recognize the importance of managing their 401(k) assets,” says IBM finance chief Mark Loughridge. As do employers: “From a fiduciary standpoint, it is becoming clearer that companies must ensure their plan participants are taken care of,” says Kathy Himsworth, principal of the institutional investor group at Vanguard.

IBM has taken a lot of flak over its decision to freeze its pension plan, following years of trying to pare it down. Like other companies, IBM must balance pension costs against employee-recruitment and -retention issues. In IBM’s case, a beefed-up 401(k) plan with a dose of financial education is the solution.

Propelled by FAS 158 and the Pension Protection Act, many companies are putting more thought into their 401(k) plans, educating employees about their options at every step and working to keep assets within the plan, thereby giving them more negotiating clout with plan providers.

The emphasis on defined-contribution plans doesn’t spell doom for IRA rollovers, which are expected to reach $7 trillion by 2011, much of it generated by 401(k) dollars. IRAs offer retirees the ability to cash out their 401(k) plans and invest the proceeds in a potpourri of stocks, bonds, annuities, and mutual funds of their choice, an investment portfolio far broader than the average 401(k) program. Even more tantalizing is the ability, courtesy of the pension legislation, to convert traditional IRAs by 2010 into Roth IRAs, which allow tax-free distributions for those who are older than 59 and a half.

But the IRA’s positives are also its negatives. “An IRA offers hundreds if not thousands of investment choices,” says Jamie Cornell, senior vice president of employer marketing for Fidelity Employer Services Co. “The more investment opportunities are provided, the more overwhelming they are.”


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