A 401(k) plan is an awesome vehicle to save for retirement!
You get to lower your tax basis (the income you get taxed on). You might get a great company match… What’s not to like?
But what do you do with your 401(k) if you leave your job?
Do you take the 401(k) with you? Where do you put it? Should you leave it?
You have some choices for your 401(k) which I’ll outline for you below:
Choices For Your 401(k) When You Leave Your Job
Leave the money in your prior employer’s 401(k) plan
Easy – What’s easier than doing nothing? If you leave the money in your prior company’s plan then you don’t have to worry about paperwork or finding new funds to put the money into.
Continue to save tax-deferred – Your money still gets the benefit of growing tax-deferred in the old 401(k) plan.
Same investment choices – You may already be happy with the investments your 401(k) plan was in. Moving the money may require you to find new funds which, in some cases, could cost you more in expenses.
Re-balancing options – Many 401(k) plans offer re-balancing options where the fund company will automatically re-balance your investments based on your instructions or alert you to re-balance once the investments grow a specified percentage from their original allocation. An IRA plan may not offer this.
No cost to move between plan options – The 401(k) plan may not cost you anything to move money between the different investments offered in the plan. With an IRA you may have to pay commissions.
Not good investment choices – Not all 401(k) plans are created equal. Some only offer a few funds to choose among while others may have high fund expenses.
Less options for beneficiaries and withdrawals – The old 401(k) may limits on your future withdrawals and who you can designate as a beneficiary.
Plan can change – You old employer can decide to move their 401(k) to another company that doesn’t offer the same options or could cost you more in fund expenses (which means a lower overall return).
Roll the money to your new employer’s 401(k) plan
Continue to save tax-deferred – Just like leaving your money in your prior employer’s plan, your money can continue to grow tax-deferred in the new plan. You also get to add money and possibly add employer matches.
Consolidate 401(k) accounts – You can keep all of your 401(k) accounts in one place, making them easier to manage. Over time, a person may have 401(k)’s from a number of jobs so it can be nice to have all of that money consolidated in one place.
May have plan options you prefer – Your current employer may have a great plan with lots of investment options and very low fees. Sometimes a large corporation will have funds in their 401(k) plan that have lower fees than are available if you tried to buy the same fund on your own.
Loan option may be available – You can’t take a loan against a 401(k) plan where you aren’t employed and you can’t take a loan against an IRA. It may not be the best option to take a loan but you at least have the option with your current employer’s 401(k) plan.
Re-balance options may be available – You new employer’s plan may have options for automatic re-balancing of your portfolio and/or alerts when the allocations change.
Defer distributions if over 70 1/2 and still working – You may be able to hold off required distributions meaning you get to let the money to continue to grow tax-deferred until you need it.
Limited investment options – There may not be many option for your money.
High fund expenses – Some company plans have investment options with higher fees than if you invested on your own in an IRA.
Plan could change – The company could change their plan and you may end up with less investment choices or higher fund fees. You can’t roll the money back out of the plan until you leave the company.
New company has no plan – Not all companies have 401(k) plans. In this case you have no option to roll money into a new 401(k) plan.
Limited withdrawal and beneficiary options – Just like in an older company’s plan, there may be limitations on future withdrawals and who you can designate as a beneficiary.
Rollover your money to an IRA
Continued tax-deferred savings – You still get to earn tax-deferred savings until you take the money out.
Keep accounts together – If you have 401(k)’s from previous employers, as well your own IRA, you may want to roll everything into one IRA so you can better manage your money. With everything in one account it is much easier to pay attention to asset allocation and you re-balance all of the money one time.
More investment choices – When you put the money into a Rollover IRA you get to choose the fund company meaning you can choose which company has the most choices for you. Most IRA custodians offer way more investment choices than a 401(k) does. In fact, with a brokerage account linked to your IRA you can have thousands of places to put your money.
Better asset allocation – With more investment choices you also get more options for asset allocation. Sometimes there isn’t much diversity in the choices in a 401(k). You can fix this when you put your money in a rollover IRA.
More choices for timing – When the money is in a rollover IRA, rather than a 401(k), you can pretty much add to the account and move money between funds whenever you want (when the market is open to trade that is). With a 401(k) you pretty much add to the account when you are paid and some plans have limitations on how many moves you can make with your money. A rollover IRA allows you more freedom.
Penalty-free withdrawal for education and first-time homebuying - A rollover IRA may allow you the option to take money out, penalty free, for education expenses as well as for a first-time home purchase ($10,000 limit). You still pay income taxes but this is a nice option you don’t have with a 401(k).
Can’t take a loan – I wouldn’t say this is a great option anyway, but there may be times when it’s necessary. A rollover IRA doesn’t have the option to take out a loan while a 401(k) may.
Your 401(k) may be in old company’s stock – If part of your 401(k) is in your prior employer’s stock then there are special considerations to take into account regarding taxes and Net Unrealized Appreciation. Check out this article on MarketWatch for more information on moving company stocks in a 401(k) to an IRA.
May not have same investment choices as 401(k) – Even though you may have a ton of choices in a rollover IRA you may not have the exact same choices as you did in your 401(k). Or if you do have the options there may be high commissions on the trades. If you like the options in your 401(k) then it could be less expensive to keep your money there rather then buy the same investments in a rollover IRA.
Commission costs – Many times, you can move money between investments in a 401(k) without and fees or commissions. In a rollover IRA, depending on the plan, you may have to pay commissions when you move money between investments.
Too many choices – Thousands of options sounds great until you have to pick out a few of them. Then the options are overwhelming. More options means more research and work. For some, too many choices can lead to paralysis analysis.
Cash out the 401(k)
You get cash. Now! – You get access to the money in your 401(k) to do with as you please. This could come in handy of you have some severe debt to take care of.
Early withdrawal penalty – If you are under 59 1/2 then you will be subject to a 10% early withdrawal penalty. Right off the bat you lose 10% of your money.
Taxes – On top of an early withdrawal penalty, you will also get hit with a 20% tax hit which could even turn our to be more when you file your taxes.
Loss of earning power – You lose out on the opportunity cost of what that money could have earned had you left it to grow tax-deferred until retirement.
Small amounts add up – Your 401(k)’s from various jobs may not add up to much individually, but together, and over time, the money can add up to a tidy sum. When you cash out your 401(k) every time you switch jobs you miss out on building wealth.
So what should you do with your 401(k) if you leave your job?
Personally, I like to have control of my money and have the option to change the investments as I like. I recently moved money from my prior job to a rollover IRA and the process was pretty easy overall. I was fortunate that my old job had a good plan and I was able to nearly duplicate the funds in my rollover IRA.
Still, you need to look at what works best for you.
I think there are a lot of easy options to invest with in a rollover IRA if you aren’t investing savvy, but for some people it might be less worrisome to leave their money in their 401(k).
In my opinion cashing out is the least desirable option. Getting a nice lump sum seems nice but you take a big penalty and tax hit and then lose out on future earnings.
Seriously consider the consequences of cashing your 401(k) out.
Some places to open a rollover IRA
Most investment firms these days have options for opening up a rollover IRA. If you are considering opening up a rollover IRA look at the investment options, fund fees, custodian fees, and commissions. (Here are some things to consider if you’re opening up a brokerage account).
A few other options for your 401(k)
You may be able to rollover a 401(k) to the following places as well as those described above: Roth IRA, SEP-IRA, 457(b), 403(b), profit-sharing plan.
What do you think are the best options for a 401(k) at a prior employer?