A significant life event like a job change often sees decisions like this get overlooked. It seems like there are other important things to focus on. But as I map out the options for you below, hopefully you will see that this is an important decision in its own right, and one that’s usually easy to make after a quick analysis. So, what can you do with that old 401(k)?
Roll it into your new 401(k) or another workplace retirement plan
Most company plans will accept rollovers. If you’re switching jobs and your new company has a plan, this is often the best option since it keeps your investments manageable and eliminates the need for multiple accounts.
Unfortunately, not all company retirement plans are created equally, and some are just plain bad. Be wary of high fees and limited investment options in particular, and don’t be afraid to consult with a professional to help sort all of this out. If there are red flags, it might not make sense to consolidate, and you’ll want to look into the next option…
Roll it into an IRA (Individual Retirement Account)
This is a great option, especially for those who don’t have a good plan at their new job, or those who won’t be returning to work for a while. An IRA is very similar to a 401k in many regards, it just isn’t attached to a company. You’ll have much more flexibility from an investment standpoint, and you can even continue to contribute money (though not as much as you could into a 401(k)).
The biggest hurdle here is that you are in charge of setting it all up. The good news is, there are tons of companies that can assist you with getting started (such as Schwab, Vanguard, or others). This is also a great time to engage with a financial planner who can provide guidance on opening the IRA, investing the rollover, and other planning opportunities that might come into play.
Cash it out
Any time you terminate employment, you have the option to cash out your 401(k). This is usually the worst option. First, the withdrawal would likely be taxed as ordinary income for the year. Additionally, if you’re under age 59½, you’ll owe a 10% penalty on the amount of your withdrawal on top of those taxes.
If you are in the common 24% tax bracket and cash out a 401(k), you’d owe the 24% Federal tax plus 5% state tax plus the 10% penalty. That’s almost 40% of your money going to taxes…you barely get to keep half! If you have a $50,000 in a 401(k), you’d only get to keep about $30,000 in that scenario. Do you really want to pay the government $20,000? Regardless of the size of your account, this is a very inefficient use of your money. Not to mention a major setback to your retirement plans.
You can leave your 401(k) where it is and it will stay invested. Be aware that this applies only if you have over $5,000 in your account. If you have under $5,000 you can be forced into an IRA or a cash-out after a certain amount of time.
No matter how much you have, this option rarely makes sense. Take your money with you and don’t leave it tied to a company you no longer work for. You don’t want to end up with a bunch of old retirement accounts that you can’t keep track of.
As you can see, it’s not as complicated as it might seem. In most cases a rollover to another company retirement plan or IRA makes the most sense. There are just a few variables you need to consider when choosing between those options. If you have more questions about what might be best for you, we would be happy to help guide you through the process. Thanks for reading!