Stop what you’re doing right now and make a list of all the retirement accounts that you have open. If you have just one account, congratulations! You’re ahead of the curve. However, if you’re like most people, you probably have multiple accounts from various employer plans, many of which you are not actively contributing to.
There’s also a pretty good chance your list is incomplete, and you’ve forgotten a few accounts along the way. These stragglers will only limit your ability to continue to grow your retirement funds. So if you want to maximize your investments, then it might be time to consolidate your 401k accounts.
Types of Retirement Plans
Retirement plans have more benefits than simply saving money in a bank account to be used when you retire. With an employer-sponsored plan, you also benefit from years (and even decades) of employer matching.
What makes retirement plans really unique, however, are the tax benefits. Most plans are tax-deferred or tax-advantaged. Here are some of the most common retirement accounts you may have already picked up in your career.
These plans are employee-funded; each month, money is pulled out of your paycheck to generate automatic contributions. In many instances, employers will match the contributions you make to your 401k. Pre-tax contributions will reduce your taxable income. The money will grow tax-deferred, and you will be taxed on withdrawals in retirement.
Traditional individual retirement accounts (IRAs)
An IRA is an account that you open and fund yourself (and not through an employer). This is the most popular type of tax-advantaged accounts. IRAs in 2020 provided an upfront tax break of $6,000, plus an extra $1,000 catch-up contribution for those ages 50 and above.
With traditional IRAs, so long as the money remains in the protection of the account, investment earnings are not taxed. Withdrawals made in retirement are taxed at the tax rate of that time.
With a Roth IRA, there is no upfront tax break. That being said, withdrawals in retirement are completely tax-free. Eligibility to contribute to a Roth IRA is based on your income. The maximum annual contribution is $6,000 (or $7,000 if you are over 50 years old).
A rollover IRA is an account that allows you to transfer assets from an old employer-sponsored retirement account to a traditional IRA. The purpose is to maintain the tax-deferred status of those assets. Rollover IRA accounts do not cap the amount of money that an employee can roll over. They also allow account holders to invest in various assets like stocks, bonds, and mutual funds.
A brokerage is a firm that buys and sells securities and assets for its clients. As the investments earn interest or dividends, the taxes accrued are taxed during that tax year. This type of account offers a lot of flexibility in your investment choices.
Many brokerage firms allow you to open an account with no initial deposit. You do, however, need to fund the account before you purchase investments. You can do this by transferring money from your personal bank account or another brokerage account.
Popular brokerage firms include Charles Schwab, Fidelity Investments, and Ameritrade.
Reasons to Consolidate Your 401k
Now that you know which retirement accounts to look for, it’s time to consolidate your investments. Here are five reasons to consolidate your disparate 401k accounts into a single fund.
Over time, fees associated with 401ks can add up. These fees can include account-level fees, fund expenses, and trading fees. Some charge annual fees above 1% of your assets each year.
If you have a handful of accounts, you’ll still pay those fees each year even if you are no longer actively contributing. As these fees increase, the growth of your savings will be hindered.
If you consolidate your 401k or transfer the money from the various accounts into an IRA, you stand to save a lot of money. IRAs tend to have lower administrative costs, and they give you more freedom to invest your money how you choose.
Everything in one place means less record keeping
When you have many different accounts, you can become swamped by emails, calls, and statements. It’s easy to lose important information and notifications this way, and you may even forget about old 401ks.
When you consolidate your 401k or retirement accounts in general, you greatly reduce the time spent on record keeping. You also reduce the risk of missing important notifications. As you age, your risk tolerance also declines, and you may need to readjust the allocation of your assets. This is a lot easier to do when you can see everything in one place.
You can better optimize your investments
When you have several accounts held in different places, it is more difficult to have a well-diversified portfolio. As an investor, you are limited to the options provided within your firm’s plan.
When you consolidate your accounts, you open yourself up to more investment options. If you go through an account custodian like Charles Schwab or Vanguard, thousands of new investment options will become available.
It will be easier to calculate your RMD
At some point in your retirement, you will be required to take money from each retirement account that you have. These are called Required Minimum Distributions (RMDs). When this starts at age 70.5, you will have multiple custodians contacting you every year to process these distributions.
If you have a lot of accounts, that means a lot of calculations need to be done. With a consolidated statement, you only need to perform one calculation.
If you fail to take out your RMDs annually, you face a 50% penalty on the amount you should have withdrawn. It becomes a lot easier to avoid those withdrawal penalties with a consolidated account.
You will simplify estate administration
If you have many accounts, estate administration will be very complicated for your heirs and the executor of your will. If you leave money behind, it will be a lot easier for your heirs to transfer money from a single account.
As you rise in your career, you may find yourself leaving behind a trail of retirement plans in your wake. Take time after starting a new job to note what retirement accounts you are leaving behind and how best to consolidate them in the future.
And as always, schedule a conversation with your financial advisor. They will provide you with guidance that ensures your retirement money is working as hard as possible for your golden years.
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