Americans who retire or change jobs face one of the most important questions of their financial lives: What to do with a 401k plan that might have ballooned to be a huge piece of their net worth after years of saving and employer matching. Excluding the value of any home equity, the 401k plan might very well account for virtually your entire net worth.
So what do you do with it after changing jobs or retiring matters?
For most Americans, a rollover IRA is the best option, as the fees are often lower and the list of potential investments generally a lot broader. Rolling your 401k balance into a rollover IRA is easy and can almost always be done with standardized forms from your new broker.
But moving the funds is only the first step. Once the funds are transferred, you still have to invest them.
When you first started working and contributing to your 401k plan, you were young and had an entire lifetime of saving and investing in front of you. An aggressive allocation to stock funds probably made sense. But by the time you move your funds to a rollover IRA, chances are good that you are in a very different stage of life, and a very different kind of allocation might be appropriate.
But this is what makes a rollover IRA such a fantastic investment vehicle. You can often hold assets in it that you would never be able to hold in a 401k plan, such as gold, real estate or even artwork.
Now, I’m not suggesting you run out and buy an Andy Warhol print with your retirement funds. But the fact is that you can consider more exotic asset allocations with a Rollover IRA than you ever could via your employer’s 401k plan.
So with no more ado, let’s jump into some assets to consider for your Rollover IRA.
I’ll start with something pretty basic: bonds.
I don’t recommend a large allocation to traditional fixed income these days because the yields are just not high enough to warrant holding. But bonds still can play a role in stabilizing a portfolio and reducing volatility.
If you’re going to own bonds, I recommend you do so via individual bond holdings rather than via a bond mutual fund. The reason is pretty simple: If you hold a bond to maturity, you have no risk of principal loss (assuming the issuer is solvent). You get the face value of the bond returned to you when it matures.
But with bond funds, this is not at all the case. Bond funds have no maturity date. So if bond yields were to have a sustained rise, we’d have a bona fide bear market in bonds, and those bond funds you bought to stabilize your portfolio will actually lose money.
While you can generally only own bond funds in a 401k plan, you can own individual bonds in a rollover IRA. It’s also worth noting that, given the unfavorable tax treatment of bond interest, which is taxed as ordinary income, it makes all the sense in the world to own your bonds via a rollover IRA than in a regular taxable account.
“Alternative investments” is a broad term that can mean a lot of things to a lot of people.
I try to keep my definition simple. To me, an alternative is anything other than stocks, bonds or cash. This can be anything from raw land to an aggressive futures trading strategy and everything in between.
With bond yields low, I’ve been using various alternatives as a substitute for bonds in client portfolios. In particular, I’ve been using market-neutral hedge funds for accredited investors and private REITs and business development companies for both accredited and ordinary investors alike. And in all cases, I’ve placed them in client rollover IRAs where possible.
This is something that requires a little research, however. You have to be careful what you hold in a rollover IRA because certain assets can create real tax headaches. The same unrelated business taxable income (UBTI) issues that make MLPs difficult to own in an IRA also make certain hedge funds (particularly those that use leverage) difficult to own.
You can often times avoid these issues by buying the offshore version of the fund for your rollover IRA.
Before you do this, make sure you discuss this with your financial advisor or with the fund’s general partner because every scenario is a little different. But as a general rule, a fund that is “tax safe” for an offshore investor will also be “tax safe” for a rollover IRA investor.
While I’m not the biggest fan of precious metals as an asset class, I do keep a few gold coins and silver bars that I never intend to sell in a safe place … just in case.
My advice is to hold previous metals in physical form and keep them in a bank safe deposit box or in a home safe and … ahem … off the books. (If you’re buying it as a crisis hedge, it’s best not to advertise to the world that you own it. Though even if you own it off the books, you’re still required to report any sales to the IRS and pay taxes accordingly on any capital gains.) But if you insist on owning them within a financial account, an IRA isn’t the worst way to do that.
Precious metals are taxed at an extremely unfavorable “collectibles” capital gains tax rate of 28%. And this applies both to physical bullion and “financialized” holdings in ETFs like the SPDR Gold Trust (ETF) (GLD).
Your average broker is not going to let you own gold coins in your rollover IRA, but there are plenty of specialty IRA shops that will. You may have to pay custodial fees, but this is still generally preferable to paying 28% in taxes.
Charles Lewis Sizemore,
CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. As of this writing, he was long AAPL and MSFT. To read more of his work, CLICK HERE NOW.
Disclaimers: If I mention a stock favorably, you should assume that I have a position in it, both personally and in client accounts. This does not, however, automatically mean that you should own it. I am expressing my opinions in this newsletter, not offering individualized financial advice or soliciting you to buy securities. See full disclaimer here.
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