Leaving a job is a significant life transition. Whether you planned to depart or not, there's a myriad of things to keep track of during that time. One of the most important is what happens to your 401(k) retirement savings plan. You want to ensure the account continues to support your overall financial goals as you start the next chapter of your life.
So what do you do with it?
If you have less than a certain balance (typically under $5,000), you may not have a choice. Your plan may force distribution to you. Depending on the balance, a check may be sent to you, or you may have the funds automatically deposited into an IRA.
However, if you have more than that threshold amount in the account, you have several options:
- Leave the money where it is
- Roll the money over into your new 401(k)
- Roll the funds into an IRA
- Cash the plan out
Depending on your situation, any of these options could make sense. Let’s look at each in turn.
Leave the Money in Your Current 401(k)
Most plans will allow you to keep your money in the account until the required minimum distributions (RMDs) come into play at age 70 ½. Since this is the most passive option, it happens quite often. People sometimes forget about the money they have stashed away. Don’t let this be you!
- This option requires no effort
- You know the plan – the investment options, the expenses, fees, and how its managed
- If you like the adviser services that come with the plan, you can stick with them
- Your funds will still grow tax-deferred, based on investment performance
- If you’re age 55+, you can take penalty-free withdrawals under the separation of service rules
- You can no longer contribute to the plan – so account growth will be based on investment returns only
- You’ll have multiple accounts to track and manage
- You’ll have a smaller pool of resources to draw from should you ever need to take a 401(k) loan
Roll Over into New 401(k)
Most plans will allow for rollovers from another plan. If not, all is not lost (see next option).
- By consolidating accounts, you’ll have less to keep track of, making your retirement planning easier
- You can take advantage of the additional compounding and pooled resources
- If you don’t like the investment options, or the plan expenses and fees are too high, moving your funds to the new 401(k) may not be the right move
Roll Over into IRA
If your new plan doesn’t allow for rollovers, or you don’t love the investment options available, you can opt to roll the funds into an IRA.
- IRAs often have more investment options and lower fees than 401(k)'s
- 401(k) plans are better shielded from creditors than IRAs
Cash the Plan Out
If you’re experiencing urgent financial hardship, such as facing eviction or foreclosure, cashing out the account could really help your situation. Otherwise, going this route will result in an unnecessary and significant hit to your funds.
If you take a distribution of the account, you will pay 20% in taxes. And, if you’re under age 59 ½, you’ll pay an additional 10% in early withdrawal fees. So if you have 100k and withdraw the full amount, you will only have 70k (100k less 20k in taxes and 10k in penalties) to actually use. If you have to pay state or other taxes, you will have even less.
- You can address an urgent financial need
- You will lose a significant chunk of the account balance due to tax and penalty
Rolling Over Your Money
There are two ways to roll over the money into a new account – direct and indirect.
With a direct rollover, the funds are transferred directly from the old financial institution to the new one. The money never passes through your hands. This type of rollover is generally preferred because it’s easy and it doesn’t result in a taxable event for you.
With an indirect rollover, the funds are issued to you. The onus of depositing the funds into an appropriate tax-sheltered account is then on you.
However, you won’t be working with the full amount of the account. The plan is required to withhold 20% in taxes. So, if you had 100k in the account, you will receive a check for 80k. Unfortunately, the complexity doesn’t stop there.
You have 60 days to deposit the funds in their new home. If you miss this deadline, you will have to pay the 10% penalty if you’re under age 59 ½. Additionally, you’ll need to deposit the full 100k into the new account (meaning you’ll have to come up with 20k quickly). If you don’t, you will be taxed on that missing 20k. And, even if you can deposit the full 100k, you won’t be able to recoup the 20k withheld until you file your taxes.
Initiating a Direct Rollover
As you can see, an indirect rollover poses many frustrating and avoidable challenges. To go the easier route, here are the steps to initiate a direct rollover:
- Check if the new plan allows for the rollover
- Contact your new plan administrator (or bank if going with an IRA) for rollover instructions
- Contact your former plan administrator and request the rollover
- Monitor the transaction’s progress
While the process is simple, it can take several weeks to complete it. Stay in regular communication with both the old and new plan holder to ensure they have everything they need to complete the rollover.
Final Thoughts on Your Old 401(k)
This article intends to provide basic information about what to do with an old 401(k) plan. As you’ve seen, there are many factors to consider – plan rules, investment options, expenses and fees, and taxes.
Since each plan is different and laws can change, please contact your plan providers for full details. Additionally, if you’re unsure which option is the best for your financial situation, consider meeting with a qualified financial planner, CPA, or other professional for guidance.
Article written by Laura