What to Do with Your 401(k) When You Change Jobs
- April 4, 2017
- by Emily
Congrats on your new job! While you’re saying goodbye to your old co-workers and preparing to take on new responsibilities and learn a different office culture, you should also think about what will become of your 401(k).
No two situations are exactly the same, so it’s hard to say what is the best option for you. Here are some of the possibilities.
You always have the option to cash out your retirement account. This strategy has some serious disadvantages, though. If you’re under 55, you’ll have to pay a 10% early withdrawal penalty, and you’ll also have to pay income taxes on the amount you cash out. For example, if you’re in a 25% tax bracket and you cash out a 401(k) worth $10,000, you’ll end up with only $6,500 after the penalties and taxes.
Sure, there are situations where this might be a smart move, like if you’ve lost a job unexpectedly and have run out of savings, or you have an emergency and need the funds. But assuming you’re just changing jobs, this isn’t a good idea.
Keeping Your Old Employer’s 401(k)
If you have more than $5,000 in your 401(k), your employer has to allow you to keep it in the company plan, even if you no longer work there. If your current 401(k) is a screaming deal, you might want to consider this option.
This option has some downsides as well. Employers who pay fees for their employees might not do so for former employees, so the plan might end up being a significantly worse investment than you think. It will also be harder for you to manage, and you might find the investment options limited.
The primary disadvantage associated with keeping your old employer’s 401(k) plan is cumulative. If you change jobs more than once or twice, you could find yourself with 5 or 6 different 401(k)s, all at different (and former) employers. That is a nightmare to manage.
Moving to your new Employer’s 401(k)
Most 401(k) plans allow you to rollover previous plans into your current employer’s plan. This is a simple way keep all of your retirement savings in one place, and it is a good idea if your employer has a great 401(k) plan.
Because they have greater bargaining power, some employers do have 401(k) plans with lower fees and higher interest rates than you would be able to find on the individual market. However, they also generally have limited investment options.
Moving to an IRA
In most circumstances, the best way to manage your old 401(k) is by moving it into a Individual Retirement Account. Make it a habit to do this whenever you change jobs. You’ll have all of your retirement savings in one place (except the 401(k) with your current employer), which will make it much easier to plan for retirement and to manage your investments.
All the major brokerages (Ameritrade, Vanguard, Fidelity, etc) offer IRA accounts. The money you put into your IRA can be invested practically any way (stocks, bonds, ETFs, mutual funds, and our favorite - low cost index funds). The number of investment choices at a major broker can be mind boggling. Usually a broker will offer a set of funds or ETFs that you can buy into commission free. Chances are good that you can find a fund that does exactly what your old employer's 401(k) did, but with lower fees.
When you roll your 401(k) into a IRA, you want to make sure the IRA is set up before you leave your job, so that the funds from the 401(k) can be transferred directly into the IRA. You don’t want to touch the money. If the money were transferred to you instead of directly into the IRA, taxes would be withheld and you would have 60 days to deposit the full 401(k) balance into your IRA to avoid early withdrawal penalties and taxes. That means you would have to come up with the amount for the withheld taxes from some other source. Save yourself the hassle and make sure the transfer is done directly from the 401(k) to your IRA. If you’re unsure how to make this happen, contact both your 401(k) administrator and the administrator for your IRA account, and make sure both explain the procedure for a direct rollover.
The bottom line: In most cases, the best thing to do with a 401(k) when you change jobs is to transfer the old 401(k) into an Individual Retirement Account. This keeps things simple even if you change jobs repeatedly. It also gives you greater flexibility than most 401(k)s do.