As you probably know, I’m a big believer in the humble 401(k) plan. Even though it’s a very basic tax shelter widely available to regular middle-class Americans, I challenge you to find something better. I’ve spent my entire professional career looking, and I have yet to find one.
If you religiously max out your 401(k) plan every year (currently $19,000 per year or $25,000 for those 50 or older), it will likely grow to become your single largest financial asset.
There’s just one big, glaring problem with the 401(k): The investment options are terrible.
Cruddy Investment Options
Most plans are limited to a menu of mediocre mutual funds that move the same direction as the market. They’re fantastic when the stock market is moving higher but a financial death sentence during a bear market. The gallows humor following the 2008 bear market was that “My 401(k) just became a 201(k).” That joke will be making the rounds again after the next bear market.
And these days, hiding in bonds won’t do much for you. With yields now hitting new all-time lows almost daily, a portfolio invested in bond funds is essentially dead money.
Some 401(k) plans have a brokerage window that allows you to buy individual stocks. That’s a nice feature if your plan offers it, but it’s not available on most plans.
No matter how cruddy the investment options are in your 401(k), taking the funds out really isn’t an option. If you’re under 59 ½, you’d have to pay a 10% penalty, and at any age you’d have to pay taxes on whatever you pull out.
An Alternative to a 401(k)
Well, I have good news for you. If you hate your 401(k) investment options, you might be able to bail on them without triggering a tax nightmare. It can be possible to roll over your 401(k) balance into an IRA while you’re still working.
As you probably know, you can always roll over your 401(k) into an IRA whenever you switch jobs or retire. But if you’re 59 ½ or older, you can legally do the same thing without having to quit your job. This is what’s called an “in-service rollover.”
Your plan might or might not offer this. It really just depends on your employer. But if your company plan does offer it, an in-service rollover might be exactly what you need.
Let’s say you’re not all that optimistic about the stock market, but you see a fantastic offer on a rental house. You could roll your 401(k) balance into an IRA and then use it to buy the property.
Or let’s say you want to invest in a hedge fund or another exotic investment. That’s difficult to do in a 401(k), but it’s not a problem at all in an IRA.
Active trading strategies? A covered call income strategy? Those might be cost-prohibitive and impractical in a 401(k) plan. But they can generally be done in an IRA with no issues.
Now, I have to insert a big, fat caveat here. Real estate, hedge funds, active trading strategies, and options all have their own quirks, and you should get a competent tax advisor to review your plans before you put them into motion. You don’t want to do something stupid that will create a major tax headache for you down the line.
But if you’re unhappy with your 401(k) plan options and want to put your money to work more productively, an in-service rollover can be one way to make that happen.
On a related note, I’ve been looking beyond the 401(k) myself in Peak Income. With the yields I’ve been finding in certain pockets of the market, I like to joke that I can turn a 401(k) into a “1201(k).”
Find out more about how I do that here.