What should I do with my former employer 401(k) plan?

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Here are your options for your old 401k plan

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Here are 5 options of what you can do with your former employer 401(k) plan.  I will discuss the advantages and disadvantages of each option. For the purposes of this article I am going to assuming that the money in your account is traditional pretax money.  There are a couple differences with Roth 401(k) savings.  Keep in mind that every 401(k) plan has its own set of rules so when going over these options remember to double check what your plan does or does not allow.

 

1. Leave the money in your old employer’s 401(k) plan.  This option is available as long as the balance in your 401(k) plan is greater than $5,000.  This can be a good option for people that are in between jobs and are not sure where they will work next. The money in your plan will stay invested with the current allocations you have.  One of the advantages of the 401(k), if you are at a large company, due to the total amount of assets in the plan you may be paying lower fees than you would within an IRA. Also, if you retired or left your company between the age of 55 and 59.5 you are eligible for a withdrawal from the 401(k) without the 10% penalty. The disadvantage of leaving it in the plan is that the company is still the owner of the account and you are simply a participant in the plan. This means your former employer can change the investment options in the plan and change which company administers the plan.  While you are invested in the plan your only investment options are the mutual funds or company stock that is offered in the plan, and for some 401(k) plans these options may be very limited.  Also, another disadvantage I have seen is the withdrawal rules in your previous plan may be limited to full withdrawals only.

 

2. Roll the 401(k) to your new employer’s plan.  This is available if your new employer offers a 401(k) plan and the plan rules allow you to roll-in your previous employer plan.  One thing to consider will be the new investment choices that are offered in the plan. This is a good option if you plan to make contributions to your new plan and would like to have your retirement assets in the same account.  Another advantage is that if you need to take a loan from your 401(k) the amount rolled over can help to increase the amount that can be borrowed.  One of the disadvantages of this strategy would be if your new plan has a poor investment menu. Also, if you do not plan to work at your new employer for the long term you will be in the same predicament in the near term.

 

3. Rollover to an IRA account.  An IRA is an Individual Retirement Arrangement that is used for your retirement savings.  These accounts can be opened at nearly all financial institutions and have the same tax consequences as your 401(k) plan.  An IRA has several advantages over leaving it in your 401(k) plan.  Once you open the IRA you then become the account owner and can choose which financial institution you would like to have your account. Also, you can choose if you want to have this account professionally managed or if you want to direct the investments yourself.  Within an IRA you are not limited to the predetermined list of mutual funds to invest in.  An IRA allows you to invest in thousands of different mutual funds, ETF’s or individual stocks.  One thing to consider if you want to have your IRA professionally managed that may increase the fees you pay compared to your company 401(k) plan.  However, on the flip side, if you are a savvy investor many firms allow you to open an IRA for free and now offer commission free trades which can allow you to save money.  Two more advantages of an IRA are: flexibility of withdrawals, meaning any amount out at any time and lastly the ability to consolidate other old 401(k) plans into one account.

 

4. Convert to a Roth IRA. The fourth option you have with an old 401(k) is to convert the pretax money into a Roth IRA.  When converting an old 401(k) plan you will have to pay taxes on the total amount that is converted into the Roth IRA account. In order to pay those taxes the best way to do so is from an after tax account.  I would suggest not converting the entire balance all in the same year. In most cases it is better to roll to an IRA first and then convert portions of the account into a Roth IRA to spread out the tax liability over several years.

 

5. Cash out your 401(k). This is the last option and should only be used in emergencies.  Keep in mind that 401(k) plans are intended to be used for long term savings accounts and to replace your paycheck in retirement.  By cashing out you will lose out on the potential for compounded returns over the length of your career.  Right now the CARES act did waive the 10% penalty and you can also delay taxes for up to three years.  If you are considering this option I strongly suggest meeting with a financial advisor to consult with them before doing so.

 

 

 

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