What to Do with Your Old 401ks
You’ve accepted a new job, congratulations! It’s all excitement and fun, until you realize you have decisions to make regarding your 401k and confusion sets in…what do you do with your 401k?!
Unfortunately, I’ve seen the old adage, “A confused mind does nothing” played out over and over again in this scenario. It’s not uncommon for someone changing jobs to have a 401k at the company they are leaving, and because they don’t know their options, they just leave it there, which may or may not be the best option for them.
When moving to a new company, you have four options for dealing with your old 401k.
Keep it where it is with your old company (if they allow it).
Roll it into your new company’s 401k plan (if they allow it).
Roll it into an IRA.
Cash it out. (Hint – this is NOT a good option and no financial advisor worth their salt would recommend it.)
Cashing out should be immediately removed from your list of options to consider. If you decide to cash out and you’re younger than 59 and a half, you’ll pay a 10 percent early withdrawal penalty. In addition, you’ll have to pay federal and state income tax on that money. As if losing all that money to penalties and taxes isn’t enough reason to keep your money invest, your 401k interest growth will suffer and be much lower than if you had kept your full amount in your 401k account.
Keep your 401k with your old company OR roll it into your new company’s 401k.
When you’re changing jobs and will be starting a new 401k, a simple option is to roll your old 401k into your new 401k with your new company. You’ll want to check with the 401k administrator to see if they allow this. A big advantage to doing this is that the transaction itself is free, you’re consolidating accounts, and there’s no management fee.
The disadvantage is that 401ks are generally built for the younger worker, and most of the options inside the 401k are market-based and therefore, have market risk. This is fine for a younger person, say 18-50 years old, but someone approaching retirement typically wants a more conservative option, which takes us to our next option…
Roll your old 401k into an IRA.
In most instances, I suggest you roll your old 401k into an IRA. I particularly recommend this if you have multiple old 401ks floating around, because this will consolidate these accounts making them easier to manage.
When you roll an old 401k into an IRA, it is called an IRA Rollover. One of the biggest advantages to this option is that the transaction is completely tax-free; the money you roll into an IRA will not be taxed, which preserves your principal.
IRAs also offer more investment choices compared to the other options. As mentioned earlier, 401ks generally have more market-based options whereas an IRA usually offers a broader array of investment choices to choose from. Some of the features IRAs may offer include being able to elect guaranteed interest rate investments, alternative investments, and in some instances, we can even elect bank CDs. In addition to these more conservative choices, you can also choose to elect any market-based investment as well, such as mutual funds, etc.
If you are on the fence about what to do, you can also execute a “partial rollover”. You would decide how much you want to roll into an IRA account and the rest of your balance would be left in your 401k.
DIY Your IRA
Many Generation X, and more and more Baby Boomers, are “do it yourselfers”. As a result, companies offering IRAs are catering to this market. Low cost, self-managed IRAs are proliferating. These are used for people who want to manage their money themselves. The transaction is tax free and the funds are allocated in the manner that you, the account holder, choose.
There are a few disadvantages to rolling your IRA that you should be aware of. An IRA Rollover can come with fees. This is not because the IRA itself comes with a fee, but rather when you roll to an IRA it’s usually done with a financial advisor, and the financial advisor will charge a fee to do this. Also, an IRA comes with the required minimum distribution, or RMD, rules. These rules require a person to take withdrawals from their traditional IRAs once they hit 70 and a half. It’s important to note that 401ks can also be subject to RMDs, so you may want to check with your tax advisor about your specific situation.
Deciding what to do with your old 401k
Before you embark on making any of these decisions, it’s best to decide what your retirement goals are and find a financial professional who can assess your particular situation and help you make the best decisions for you.
Once you’ve determined your goals, we can create an investment strategy to help you reach those goals, and part of that strategy is deciding how best to use your old 401ks. The “Confused Mind Strategy” is NOT a winning game plan, and by proactively considering your options, you will start to feel more confident in your choices and know which option to choose.