To many people, the act of consolidating retirement accounts may not seem a big deal. After all, it sounds like just a small, administrative step. Which is true – there isn’t much action involved.
But, small actions can have powerful impacts.
Bruce Lee, the martial arts master and action movie icon, became famous with theatrical displays of sensational, acrobatic acts of violence. Yet, arguably his most legendary feat was the one-inch punch. In this punching exercise, a practitioner stands with a fist close to the target and then uses the concentrated force of the full body’s muscles and joints to deliver an explosive blow.
Lee first publicly demonstrated the one-inch at the Long Beach International Karate Championships in 1964, during which he sent his poor fellow practitioner flying into a chair. A test of the one-inch punch on a cable television program showed that it was 1.7 times more injurious than a 30-m.p.h. car crash with modern safety features. Needless to say, you can generate a lot of power with just one inch.
The same can be said of small financial moves such as consolidating retirement accounts, typically into an IRA.
The average worker stays at each job for 4.6 years, according to the Bureau of Labor Statistics. Over a 30- to 40-year career, that could mean having to juggle many separate accounts. Putting your full retirement savings to work in one place, just like a one-inch punch, can provide some powerful financial benefits, including:
Simplifying your financial life
Consolidating your retirement accounts in a single account is convenient for two important reasons. First, it allows you to manage all your assets under a cohesive investment strategy that is appropriate for your specific financial needs. It’s very difficult to apply a single investment strategy across many separate accounts considering that investment options vary from one employer’s plan to another.
Second, having your retirement savings in one place makes it easier to monitor your progress and make changes as needed.
Greater investment choices and flexibility, lower costs
An IRA can give you a much larger pool of investments to choose from than any employer-sponsored retirement account. More investment options mean greater flexibility to create an investment portfolio that is better aligned with your current financial situation, retirement goals and risk tolerance. Also, with a wider selection of investments, you may be able to lower your fees and expenses with lower-cost investments.
Professional investment management
Generally, in any employer retirement account, what you see is what you get. And, it’s up to you to select and manage your investments. When your savings are combined in an IRA, however, a financial adviser can help you choose investments that appropriately fit your financial needs and goals. Further, an adviser can directly adjust your portfolio as market conditions or your needs change.
Continued tax benefits and growth
An IRA provides similar tax advantages that are typically offered in 401(k) plans or other retirement accounts. Earnings in a traditional IRA are tax-deferred. With a Roth IRA, your earnings and withdrawals are tax-free; however, any pre-tax dollars you convert to a Roth are subject to ordinary income tax.
Retirees also have the option of cashing out their retirement accounts. But, this is a choice of last resort, as it can potentially trigger a large tax event since you’ve likely accumulated a significant pool of money. Plus, cash is unable to generate growth like investments such as stocks and bonds.
No withdrawal penalties
If you withdraw money from your employer retirement account, it may be subject to income taxes and a 10% early withdrawal penalty if you’re under age 59 ½. (The exception is if you separate from your employer or retire in the year in which you turn age 55 or older. Then you can take withdrawals without incurring the 10% early withdrawal penalty, even though you're under age 59 ½.)
When you transfer funds from an employer’s plan directly to a traditional IRA, on the other hand, that money is not subject to income taxes or the early withdrawal penalty. Plus, assets rolled over to an IRA can remain invested and can continue to grow.
When to leave a retirement account untouched
Of course, moving your money doesn’t always make sense. If you have a good employer retirement plan with suitable investment choices and low fees, then you may be better off keeping it where it is. There’s always potential transaction fees and taxes to consider. Also, as mentioned above, if you retire from your company in the year in which you turn age 55 or older, you have full flexibility regarding withdrawals from your 401(k), meaning no early withdrawal penalties.
Ultimately, when consolidating retirement accounts, it’s best to work with a financial adviser to ensure that you’re moving the right accounts, avoiding unnecessary taxes and following an investment strategy that aligns with your financial goals.