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401-K: To Rollover Or Not To Rollover

I have a $1M 401-K with a company which invests it in a Vanguard 500 Index Fund (and charges me $9K annually (0.09%) to manage it). I'm still working (and plan to continue), I max out my contribution, my firm makes a modest match, hence no RMD yet.

I have a $750K Traditional IRA, also in the Vanguard 500 Index Fund, which Vanguard charges 0.04% to manage. I must take a $30K annual RMD. I'm in the Federal 35% tax bracket.

I calculate that if I rollover half my 401-K into a traditional Vanguard 500 Index Fund IRA, my 401-K fee would be cut in half, but the RMD would increase to $50K. The additional $20K would be reduced to $12K by federal and state taxes.

I don't need the extra income. I already make use of QCD's for part of the current RMD.

The way I see it, a rollover would give me greater flexibility, but not much tax advantage.

Anyone have suggestion?

Comments

  • Not all plans allow "in-service rollovers". I see that you are at RMD+ age and still working.

    If your company does, then yes, you can roll into T-IRA and invest in anything.
  • Thanks for the reply. My 401-K plan does allow rollovers while still employed, but I'm still questioning whether there's any advantage to doing it.
  • Introductory question: if it were economically better to roll half the 401(k) into an IRA, wouldn't the benefit be even greater if you rolled the whole 401(k) into an IRA?

    It's pretty clear that if your tax rates (or those of your beneficiaries) are lower in retirement, you're better off keeping the money in your 401(k). That's assuming you would use the same investment, the only difference being an extra 5 basis points in expenses.

    Say you continue employment for another decade. (After retirement, you'd have RMDs in the 401(k) so there would be little reason to keep the money in that higher cost vehicle as opposed to a lower cost IRA).

    So your investment cost for not moving the money would be about 10 x 5 basis point = 1/2%. (This ignores the minuscule compounding effect of 5 basis points.) That is petty in comparison with the reduction in taxes (if any) post-retirement.

    OTOH, even if there is no reduction in taxes, by moving $500K to the IRA, you'd lose the (investment) use of the taxes owed on $20K/year. That is, you lose the tax deferral value of keeping the RMD amount tax-sheltered.

    At 40% (your current tax rate), that's $8K in taxes paid early that you won't have to invest. And you lose the use of an additional $8K each year for however long you still work and could defer RMDs with your 401(k).

    Let's say that you get 5% return on your S&P 500 investment. If you leave the $500K in the 401(k), then each year, for so long as you work, you'll have an additional $8K earning 5% ($400) that you wouldn't have had by using the IRA. That's $400 extra the first year, $800 extra the second year, etc. The cost to you for those earnings is 5 basis points on $500K/year or $250/year.

    Of course you'll owe taxes on those extra earnings once you withdraw them from your retirement plan. So the gain isn't quite this large, but it's still clearly positive. Even if your taxes don't go down in retirement.

    The choice seems obvious. Saving 5 basis points is not worth the loss of use of tax money, let alone potential lower tax rates if distributions are deferred until (actual) retirement.

    It might be worth the additional flexibility, but that's a whole 'nother story.
  • MSF - Thank you for analyzing the ramifications of doing a rollover at this time. The math was too complex for my mind. I was more objecting to Sequoia getting $9K a year for doing essentially nothing that Vanguard wasn't already doing, but it looks like I'd be cutting off my nose to spite my face. The $9K fee is a small price to pay for keeping the 401-K tax sheltered for now! Thanks again!
  • I'd be upset about $9K as well. One of us is off a decimal place. I think it's you:-)

    0.09% x $1,000,000 = 0.9% x $100,000 = 9% x $10,000 = 90% x $1,000 = $900

    If they're really charging $9K, the analysis is a lot different. Let me know.
  • @bilvihur, you are overlooking main point by @msf that so long as you are working, your 401k won't require RMDs. But as soon as you shift some (half?), the RMDs will kick in within the T-IRA. That may be a bigger tax hit than parts of $900 that you may save.
  • edited March 2023
    You're right again MSF. It's a 0.92% annual administrative fee for my 401-K.
    0.92% = 0.0092 x 1000000 = 9200.
    0.04% = 0.0004 x 1000000 = 400.
    Yes, there is a big difference!
  • You're right again MSF. It's a 0.92% annual administrative fee for my 401-K.
    0.92% = 0.0092 x 1000000 = 9200.
    0.04% = 0.0004 x 1000000 = 400.
    Yes, there is a big difference!
  • Any changes to your guidance?
  • msf
    edited March 2023
    There are too many variables and possibilities for me to write up a complete description let alone an analysis right now. Difference in tax rates post-retirement, number of years until retirement (at which point you should switch to IRA since the 401(k) then offers no more deferral of RMDs), number of anticipated years of life (not IRS tables), type of beneficiary (spouse or other), expected rate of return (and variability of returns).

    Broad picture - the more your tax rates drop in retirement the better off you are in keeping the money in the 401(k), since that will avoid RMDs until they're taxed at the lower rates. That tax savings can more than compensate for the extra fees in the meantime.

    If there's no change in rates, the picture changes. Each year you pay $8K in taxes using the IRA, meaning you have $8K less earning returns. Keep the $500K in the 401(k) and you have $4800 less due to fees that can earn returns. So you've got about $3.2K more with the 401(k) sitting there earning returns.

    But while the $4800 loss to fees in the 401(k) is permanent, the loss of an extra $8K in taxes with the IRA is temporary. Keeping the money in the 401(k), sooner or later, you'd still withdraw the $20K, post-retirement, and pay the $8K in taxes then.

    I don't have the time right now to delve more deeply into this. Gut feeling is that a sizeable post-retirement reduction in tax rates would justify keeping the money in the 401(k). Otherwise, moving the money to the IRA may come out better.
  • MSF - I really appreciate the effort you put into this analysis! I'm 75, widowed, good health (so far), earning $60K (after 401-K contribution) from working part-time (which I plan to continue). Most of my income is from investments, pension, and SS. True retirement would probably drop me into the 32% federal tax bracket. Thanks for your insight!
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