Got a New Job? Here’s What to Do With Your Old 401(k)
If you’re thinking about leaving a job, your retirement savings account may not be at the top of your mind.
But it should be.
Your employer-sponsored 401(k) is one of the biggest perks your company can offer, so don’t forget it when you leave.
You have a few options:
- Leave the money where it is with your previous employer.
- Roll over the balance into a new employer’s 401(k).
- Roll over the account into an IRA.
- Cash out the account.
Consider factors like your age, current financial situation and retirement savings style, as well as your former and new employer’s plan details when making your decision.
1. Leave the Money Where It Is
Of all your 401(k) options, this is the easiest.
Your money continues to grow tax-deferred just like it did when you worked at your previous place of employment, but you probably won’t be able to make additional contributions once you leave.
If your account has more than $5,000, you have the most flexibility to leave your money where it is.
Much of this decision depends on how good your current 401(k) plan is. If the fees are low and you like your investment options, stick with it. If not, consider other options.
The downside of leaving your money is some employers charge higher fees if you’re not an active employee. You probably won’t be able to take a plan loan or a partial withdrawal.
Plus, since you’re not an active employee, you may miss information on plan changes.
While you may remember this account the first time you change jobs, you might completely forget it exists by the time you’re on your third or fourth job — and third or fourth 401(k).
It’s important to keep track of all of your retirement accounts — and those pesky usernames and passwords — so you can periodically rebalance your portfolio and ensure your savings are on track.
Many financial advisers say having your money spread out can make it harder to know if your investments are truly diverse and working together toward your financial goals.
2. Roll Over Your Old 401(k) to Your New Employer’s Plan
This is not an option at all workplaces, so check with your new employer first.
You may have to wait until a probation period ends to begin participating in your new employer’s plan.
This option allows your retirement savings to continue growing, tax-deferred. It also allows you to make additional contributions to the account, unlike leaving your money behind.
Your new employer may have a plan with lower fees or better investment options, and you’ll likely be able to take a plan loan.
Rolling your 401(k) over into your new employer’s plan means you only have to look in one place to see how your money is doing and you’ll have the clearest picture of your retirement savings.
To roll over your old 401(k) into a new one, you’ll need to ask your former employer to send over the value of your old account to the administrator of your new plan.
You have two options:
- Direct rollover: Your old plan administrator transfers the money directly to your new 401(k) account.
- Indirect rollover: Your old plan administrator transfers the money to you directly and you manually add the money to your new account. You might do this if you’re in need of a short-term loan. However, this option is slightly more complicated.
When you opt for an indirect rollover, your employer will withhold 20% for federal taxes, in case you decide to keep the money.
If you roll over all the money within 60 days, the 20% will be returned to you when you file your tax return for the year.
However, keep in mind that you’ll need to come up with the 20% elsewhere — otherwise you will be penalized.
You may also pay an early distribution fee if you are younger than 59 1/2.
3. Roll Over Into an IRA
Another option is rolling over your 401(k) funds into an individual retirement account, or IRA. This account is not attached to an employer.
Again, you can send the funds directly or indirectly. If you move your funds from a traditional 401(k) to a traditional IRA, you won’t pay taxes like you would if you moved your funds to a Roth IRA.
This is a good option for people leaving the workforce to become stay-at-home parents or to go back to school, as they don’t have access to another 401(k).
An IRA allows you to grow your money tax-deferred, like your 401(k) did, but likely includes a wider variety of investment options. You won’t pay an early penalty tax if you withdraw money for college, a first home purchase or medical bills.
When considering an IRA, figure out what level of involvement you want to have in your investments. You can choose from varying levels of professional service for IRAs, but you’ll pay higher fees to have someone else manage your money.
If you’re debating between an IRA rollover and a 401(k), make sure to compare fees when making your decision.
Your employer may be paying for some — or all — of your plan’s fees, and it may also foot the bill for helpful planning tools, education materials and workshops.
4. Cashing Out Your 401(k)
About 31% of people cash out their 401(k)s within the first year of leaving their jobs, according to a 2017 report by Retirement Clearinghouse. Another 11% cash out their 401(k)s between two and eight years after they change jobs.
Most financial planners argue against cashing out your 401(k): Because of taxes and penalties, you won’t get all the money you and your employer have invested.
On the other hand, maybe you need a big lump sum of cash to start your own business, to go back to school or to serve as a liquid nest egg when one parent decides to stay home with the kids.
But considering all the money you’ll lose in the long run, you may be better off taking out a loan with a low interest rate.
Here’s what it costs to cash out:
- Your employer will generally withhold about 20% of your balance to pay the IRS. Plus, you’ll pay state taxes.
- If you’re younger than 59 1/2, you’ll also likely have to pay a 10% early withdrawal fee.
These immediate costs don’t factor in the money you lose when you don’t let your money grow. With a 401(k) account, you don’t have to pay taxes until you withdraw money at retirement. By cashing out too soon, you’re missing out on the gains your money could be making during your career.
If you understand the power of compound interest — which is what fuels investment returns — you might be less tempted to tap into that money. Say you’re 35 years old with $50,000 in your 401(k) and you plan to retire at the age of 65. If you keep your money in a 401(k) with an estimated 5% rate of return, your account could be worth more than $216,000 when you retire.
But if you cash out now? You’ll walk away with just $35,000.
Sarah Kuta is an education reporter in Boulder, Colorado, with a penchant for weekend thrifting, furniture refurbishment and good deals. Find her on Twitter: @sarahkuta.
Editor Caitlin Constantine contributed to this post.