What Should You Do With Your 401(k) When You Change Jobs?

This is a question that most people will face sooner or later, since labor statistics indicate that the average person entering the workforce will change jobs at least seven times. What follows is a short discussion of some of the key considerations that should be kept in mind as you evaluate this question. This summary is not personalized financial advice; remember that there will be tax and/or other financial consequences depending on what you decide to do.

Every few weeks, I get some sort of mailing from one of various investment firms urging me to roll my old retirement accounts into their fund family.  Mutual funds love to accumulate assets, because assets generate income for them.  But before you roll over your 401(k) or other retirement account, it’s wise to consider all your options and analyze them.

Your Options Include

  • Cashing out of the old 401(k) account
  • Rolling the funds into your new employer’s plan
  • Keeping the money in the old 401(k) account
  • Rolling the funds into an IRA

Cash out of the old 401(k) account –
For most people, this is the worst option.  Often if you do this you’ll have to pay state and federal income taxes, plus a 10% penalty tax, on the funds taken out.  You’ll also forfeit any future tax-deferred growth that you would have gotten by keeping the money in a retirement account.  In most cases, this should only be done if you desperately need the money.

Roll the funds over into your new employer’s 401(k) or other retirement plan –
Many employer plans will not accept rollovers, so first you must determine whether this is even an option.  If your new employer’s plan includes several desirable investment options and low fees, this could be a good choice.  Be sure that you understand the rules for both the old and new plans.  In any case, if you do the rollover it probably should be a “trustee-to-trustee” transaction.  If you fail to do this and instead have the old plan issue a check to you, this will trigger a 20% withholding tax and will complicate the transaction quite a bit.

Keep the money in your old 401(k) account –
This might be a good idea, depending on the specifics of the plan.  This option usually involves the smallest amount of paperwork, but if you’re not comfortable dealing with your former employer, you may not wish to do it.  Two things that you should determine about your old plan as you consider this option are:

What are the investment options/restrictions? – Some plans have very poor investment options, but other plans include mutual funds that you can’t easily invest in elsewhere.  Staying in your old plan could be a good choice if it includes top-notch funds that are closed to new investors, funds in which the customary load fees are waived, or special institutional funds with extremely low fund expenses and/or very high account balance minimums.  However, some 401(k) plan rules include restrictions on fund withdrawals and exchanges that would not be present in IRA account.

How much are the administrative fees? – Some plans charge no administrative costs while you’re employed, but begin charging you a fee after you leave. Some employers shoulder all the administrative costs for their plan, while other plans have fees that are simply too high relative to what you’d pay if you rolled the money into an IRA.  You need to check the plan documents carefully to determine whether the administrative costs are reasonable.

Depending on your state of residence, 401(k) funds may be better protected from your creditors than money in an IRA (this would also apply, of course, if you rolled the funds into a new 401(k) plan).  However, federal bankruptcy law protects up to $1 million in IRA holdings from creditors.

This option still leaves open the possibility of rolling over your funds into an IRA or a new employer’s retirement plan at a future date.

Transfer the funds to your own IRA –
This choice usually provides the widest possible range of investment options.  Some people find this reason alone very compelling because most 401(k) plans don’t provide enough different asset class options to develop a fully-diversified retirement portfolio.  However, if your old 401(k) includes some great investment options with reasonable fees, it could make sense to retain it and use another retirement account to round out the shortcomings in your old plan.

It’s now possible to roll an employer plan directly to a Roth IRA, which would normally trigger taxes.  The suitability of moving to a Roth will depend on your specific tax situation, and it might even be preferable to make an intermediate transfer to a traditional IRA first.  For example, if you have a qualified plan that contains both before- and after-tax funds, the situation is complex; you should probably consult an adviser if this is your situation.

Be sure to determine the maintenance fee structure of any IRA account that you’re considering.  Some IRA custodians charge an annual maintenance fee and/or a fee for accounts containing less than a specified amount.

Funds moved into an IRA can usually be rolled over in the future to a new 401(k) or IRA; the ability to do this will depend on the specific situation.

Other special considerations:
If your old 401(k) contains company stock, it may be desirable to make a special taxable transfer that takes advantage of tax laws pertaining to net unrealized appreciation.  This is a transaction that must be done properly or the tax benefits are forfeited.  Make sure you understand the benefits and consequences of such a transfer if you’re in this situation.

Finally, it is worth saying one more time: if you’re going to roll over your retirement funds to any other account, it is generally best to do it through a trustee-to-trustee transfer in order to avoid the risk of adverse tax consequences.

photo by: Stalin

About the author

Thomas Fisher, CFP®
Thomas Fisher, CFP®

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  • I need to rollover my old 401k accounts from my previous employers. What are some reputable companies you can refer me to so I can open up an IRA account? Who has the lowest fees without sacrifycing quality and risk?

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