Considering Rollover My 401(k)

Last week, when my previous employer informed me that the company match for the first 6 months has been credited to my 401(k) account at Fidelity, I was also told that my account status will be changed to “Terminated” on August 31st. That means I can move the money to other accounts starting September 1st. The first option came to my mind was to roll it over to Vanguard where I have a Roth IRA account. There are three factors I considered in my decision making:

1. Investment choices
2. Expenses
3. Taxes

No, performance isn’t really one of my concerns.

Investment choices and costs

One of the disadvantages of employer sponsored retirement plans is the selection of investments. Since my previous employer uses Fidelity to manage the company’s 401(k) plan, I could only choose from a number of Fidelity mutual funds to make my contribution. In addition to the limited selections, the costs for those funds are not ideal either. For the four funds I own in my account, the expense ratio (ER) of FFTHX is 0.8%, FCPVX 1.06%, FRESX 0.82%, and FDGFX 0.59%. Obviously, if I want to hold the funds for something like 30 years, I can use some less expensive choices. In that sense, nobody beats Vanguard. The ERs of the four Vanguard funds in my Roth IRA account are: VGTSX 0.32%, VIPSX 0.20%, VGTSX 0.32%, and VWELX 0.30%. The decision doesn’t seem to be too difficult to make.

Taxes

My main concern is tax consequences of the rollover and whether I want to pay taxes now or in the future. Since 401(k) contributions are made before taxes and Roth IRA takes after-tax money, I will have to pay taxes for the contributions made in my 401(k) if I choose to convert from Traditional to Roth after the rollover. Last year, we lost the eligibility to contribute to Roth IRAs as our annual income exceeded the threshold and had to withdraw almost all the $4,000 contributed last year (converted from Roth to Traditional). This year, it could happen again. If that’s the case, I may choose to postpone the conversion till 2010 when the income limitation is lifted to do the conversion all at once. The problem for this option, however, is I may have to pay more federal income taxes if I am in a higher tax bracket at that time. If I choose to do the conversion in 2010, the tax bill can be split two years (2011 and 2012) instead of paying it in a single year if a conversion occurs in 2007.

The procedure

I contacted Vanguard yesterday to inquiry the rollover procedure. In order to move the money from Fidelity to Vanguard, I will need to open an Roll over IRA account first, which is essentially a Traditional IRA account, as there is no direct transfer from 401(k) to Roth IRA. Once the account is opened, I can instruct Vanguard to initiate the roll over process without having to deal with Fidelity myself. After the completion of the roll over, I can immediately convert the Traditional IRA into a Roth.

Or I could wait three more months to directly roll 401(k) over to Roth in 2008 to make the process a little easier, according to the new tax law.

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