What to do with an old 401(k)?

Sit? Stay? Rollover? Follow these guidelines for consideration around your old retirement accounts

Leaving a job can be tough.  You may be leaving behind stability, comfort, some good friends and, importantly, your old 401(k). Perhaps you find yourself accumulating retirement accounts and, once a year when you get your statement, you think: "What should I do with this thing?" You have options.

You have four options—this goes for 403(b)s and 457s, too

1. Leave it where it is with your old employer 

2. Roll it into your new employer's 401(k)

3. Roll it into a rollover IRA

4. Cash it out (We rarely recommend this one. It generates a tax bill and most likely penalties. It is also counter productive to saving for retirement, so don't start thinking you have extra sushi money!)

Option 1, Stay: Leave it with your previous employer

Pros:

• Your money will continue to grow tax deferred, a benefit for retirement.

• The investment options are familiar.

• Your ETFs and target date retirement funds could make your investment options more simplified and diversified.

• You may incur lower fees. If you like your investment options and have access to the institutional share classes through the 401(k), you may have fewer fees than if you were in the retail share class through a rollover IRA.

• Some employer sponsored retirement plans offer low cost or free professional guidance

• Employer sponsored retirement plans provide broader creditor protection under federal law than an IRA

Cons:

• A smaller account with an old employer may fall off your radar a bit when it comes time to seriously consider your retirement finances.

• Most employers have minimum balance requirements (typically around $5,000).  If you have less than the minimum balance, your funds may automatically be distributed to you or to an IRA.

• You will no longer be able to contribute to this plan and most likely not take a 401(k) loan.

• Your withdrawal options may be limited.

Option 2, Rollover into your new employer-sponsored 401(k)

Pros:

• Enjoy all of the benefits listed in Option 1 (see above)

• Simplification! You only having to monitor, track and plan for one account instead of two or more.

• Potential borrowing power though your new 401(k) if your employer allows "in-service" loans. A common borrowing limit is 50 percent of vested balance up to $50,000. Check with your administrator to be sure.

Cons:

• Evaluate both plans first to see which benefits you will leave behind with your old 401(k), such as investment options and performance, administration and fund fees, access to professional advice, and any loan options.

• Not all employers will accept a rollover from a previous employer’s plan, so be sure to check with your new employer

Careful!

• Contact your new employer's HR department to learn the proper steps to make a "rollover contribution"

• Confirm with your new employer's HR department that you are making a "direct rollover." This should be a clear option on your paperwork or online form.  A direct rollover, trustee to trustee (401(k) plan to 401(k) plan) is the most simple and convenient rollover option. This way your former and current 401(k) plan administrators will manage the transaction for you.

• An alternative option is an "indirect rollover", where your former employer will send you a check less 20 percent of your balance for taxes. You are responsible for properly depositing the funds on time (within 60 days); otherwise, you will be subject to a 10% penalty and taxes. You must also deposit the 20 percent your employer withheld into your rollover from excess cash. Otherwise, those funds are considered a distribution for which you will owe tax and penalties.  Come tax time, you will be reimbursed this withholding. Because of this cluster-beep complication and risk for error/penalties, we recommend direct rollovers whenever possible.

Option 3 Rollover into a Rollover IRA

Pros:

• Your money has the chance to continue to grow tax deferred. If you’re under age 59½, you can withdraw money penalty-free for a qualifying first-time home purchase or higher education expenses. You'll notice we rarely recommend any IRA withdrawals; we're fans of socking away as much as possible for retirement.

• You'll have a broader range of investment choices as opposed to being limited to the options in your 401(k).

Cons:

• Evaluate your old plan to see which benefits you will forego when moving out of the old 401(k) into an IRA. Benefits you may leave behind include the simplicity of target date fund investment options, access to professional advice, loan options, potential lower fees, etc.

• After you reach age 70½, you must take annual required minimum distributions (RMDs) from a traditional IRA every year, even if you're still working. If the funds are in a 401(k) and you are still working, you do not need to take distributions.

Careful!

• Contact your previous employer's HR department for instructions to make a "direct IRA rollover".

• Like the 401(k) direct rollover, again, the most important thing is to be sure you're making a "direct rollover." This should be a clear option on your paperwork, or online form.  A direct rollover, trustee to trustee (in this case, 401k plan to IRA custodian) is the most simple and convenient way to do a rollover, where he old 401k plan administrator will send the rollover directly to the new IRA custodian and handle more of the rollover for you. 

• An alternative option is an "indirect rollover" (as we mention above), where your former employer will send you a check less 20 percent of your balance for taxes. You are responsible for properly depositing the funds on time (within 60 days); otherwise, you will be subject to a 10% penalty and taxes. You must also deposit the 20 percent your employer withheld into your rollover from excess cash. Otherwise, those funds are considered a distribution for which you will owe tax and penalties.  Come tax time, you will be reimbursed this withholding. Because of this complication and risk for error/penalties, we recommend direct rollovers whenever possible.

Option 4 Run: Cash it out

Pros:

• Only cash out your 401(k) plan if you critically need cash. This route is counter to saving for retirement.

Cons:

• Consequences can vary depending on your age and your personal tax situation.

• Typically a 401(k) withdraw before age 59½ will be subject to taxes and a potential 10 percent early withdrawal penalty. If you're between the ages of 55-59 1/2 you have some leeway in distributing these funds. 

• Penalties and taxes can be substantial. You are now subject to tax on this distribution and the distribution could push you into a higher income bracket.