Streamlining your retirement accounts? Think through the key variables first.
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By Christine Benz | 12-28-10 | 06:00 AM | Email Article

This article originally appeared on Morningstar.com in December 2010. In case you missed it, we're running it again as part of our IRA Improvement Week.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Question: Streamlining my financial accounts is on my 2011 to-do list, and I'd like to roll over a 401(k) into an IRA. But I have a few questions.

First, can I do a partial rollover--that is, roll most of my money into an IRA but leave some behind in the 401(k)? (My old 401(k) includes a stable value fund, and these aren't available via IRAs.)

Second, can I roll the money into accounts at more than one provider? I have accounts at Vanguard and E-Trade, and I'd like to split my old 401(k) assets between the two.

Finally, if I decide to do a rollover, can I roll my money directly into a Roth IRA, or do I have to roll it into a traditional IRA first?

Answer: First, kudos to you for taking steps to streamline the number of accounts that you hold. Doing so will give you fewer moving parts to monitor on an ongoing basis--a valuable benefit.

And by rolling over your old 401(k) into an IRA, you may also be able to reduce the amount of fees you pay on an ongoing basis and improve your investment performance. Many 401(k) plans contain extra layers of fees, and the individual investment options may be costly and/or subpar. By investing in an IRA, by contrast, you'll be able to select among best-of-breed investment options, and you won't pay any additional layers of administrative costs.

But as your question highlights, sinking all of your 401(k) balance into an IRA isn't always a perfect choice. For one thing, assets held within the confines of a company retirement plan may have greater legal protections than IRA assets, a consideration to bear in mind if there's a possibility you could be sued or need creditor protection. (The extent to which IRA assets are protected in such situations will vary by state.) Moreover, 401(k)s vary dramatically. If you work for a large employer, your company retirement plan 401(k) plan might not be levying any additional costs, and it might also offer investment options that aren't available to you as an individual, do-it-yourself investor devoting money to an IRA. For example, your 401(k) may provide access to ultracheap institutional share classes of mutual funds or investment options that are only available through company retirement plans, such as your stable-value fund.

So, to answer your first question, is it possible to find the best of all worlds--rolling some of your assets into an IRA and leaving some money behind in those investment choices that are impossible to replicate outside of a company retirement plan? The short answer is that it depends on the plan. Although the Internal Revenue Service doesn't prohibit partial rollovers, some plans allow them, while others take an all-or-nothing approach, meaning you must either roll over your entire balance into an IRA or leave it all behind. Check with your 401(k) plan administrator for details on how your plan works.

The answer to your second question is yes, you can roll over your 401(k) balance into IRA accounts at multiple providers. Just bear in mind that a frequent goal of an IRA rollover (and it sounds like one of your overarching goals, too) is to streamline multiple accounts, and you won't necessarily be achieving this by splitting your old 401(k) balance across several firms. Furthermore, with multiple investment providers in the mix, you'll need to take extra care to ensure that the rollovers are completed in accordance with IRS guidelines; if the transfers aren't handled correctly, you'll owe taxes and a penalty on your 401(k) balance. For that reason, a direct, or trustee-to-trustee, rollover is the way to go, meaning that the financial institutions deal with one another on the rollover and you never put your hands on the money.

As to your final question, it's now a lot easier than it once was to roll over traditional 401(k) assets into a Roth IRA. In the past, you had to first roll the money into a traditional IRA and then convert those assets to a Roth IRA, but now you can move the money directly from your 401(k) to a Roth IRA.

Before doing so, however, there are a couple of key considerations. The main one is that you'll owe taxes when you make the rollover, just as you would if you converted a traditional IRA to a Roth. This article details some of the key considerations to bear in mind when mulling a conversion from a traditional IRA to a Roth, and the key factors are nearly identical for rollovers from a traditional 401(k) to a Roth IRA.

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