The Rollover Recommendation
Your client, Maya, age 52, has $320,000 in her former employer's 401(k). She wants to roll it into an IRA to access a broader range of investments. The 401(k) has low-cost institutional funds (average expense ratio 0.10%) and a stable value fund yielding 3.5%. The IRA you recommend has an average expense ratio of 0.75% and an advisory fee of 0.80% annually. Maya's marginal tax rate is 24%, and she plans to retire at 65. She mentions that she might need to take a loan from her account in the next few years for a home renovation. The 401(k) allows loans; IRAs do not. You are a fiduciary and must document the basis for your rollover recommendation.
1. What factors should you consider in determining whether the rollover is in Maya's best interest?
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As a fiduciary, you must evaluate whether the rollover is in Maya's best interest. Key factors include:
- Fees and expenses: Compare the total cost of the 401(k) (0.10% expense ratio) versus the IRA (0.75% expense ratio + 0.80% advisory fee = 1.55% total). The higher fees reduce Maya's returns.
- Investment options: The 401(k) offers institutional funds and a stable value fund; the IRA offers a broader range but at higher cost. Assess whether the broader options are necessary for Maya's goals.
- Services: Consider the value of advisory services Maya would receive in the IRA versus the limited services in the 401(k).
- Loan feature: Maya may need a loan for home renovation. The 401(k) allows loans; IRAs do not. This is a significant constraint.
- Tax implications: Both are tax-deferred, so no immediate tax impact, but future withdrawals are taxed as ordinary income.
- Age and retirement horizon: Maya is 52 and plans to retire at 65, so a 13-year horizon. The higher fees could significantly erode returns over time.
You must document these factors and conclude whether the rollover is beneficial. Given the higher fees and loss of loan feature, the rollover may not be in her best interest unless the advisory services and broader investments justify the cost.
2. If you proceed with the rollover, what disclosures and documentation should you provide to Maya?
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If you proceed, you must provide full disclosure and documentation:
- Written disclosure of all fees and expenses: the IRA's expense ratio (0.75%), your advisory fee (0.80%), and any other costs. Compare these to the 401(k) fees (0.10%).
- Explain the loss of the loan feature and how it may affect her home renovation plans.
- Describe the services you will provide for the advisory fee.
- Document the rationale for the recommendation, including why the rollover is in her best interest despite higher costs (e.g., broader investment options, professional management, consolidation).
- Provide a comparison of the 401(k) and IRA options, including projected outcomes over 13 years.
- Obtain Maya's signed acknowledgment that she understands the fees and loss of loan option.
- Keep records of the analysis and disclosure for compliance.
This documentation satisfies fiduciary duties and regulatory requirements.