So you’re leaving your job, or have already moved on to an exciting new career opportunity, but you have some unfinished business with your old employer: You still have a 401(k) account with a tidy pile of money in it.
The big question is: What should you do about it? You’ve technically got four options: leave the money with your old company’s plan, roll your account into an IRA, move your money into your new employer’s plan or take a distribution.
“The last option is rarely a good one due to the taxes that will be due and the 10% penalty for those under 59½,” Roger Wohlner, a financial adviser and freelance financial writer at the Chicago Financial Planner, said in an email interview. “The other options will preserve the tax deferral, however, it is important to do a ‘trustee to trustee’ transfer — to either a new employer’s plan or an IRA — to avoid any potential (and accidental) tax hit.”
If you simply cash in your 401(k), the consequences can be dire. “Your employer is required to withhold 20% for federal income taxes, you’ll pay a 10% premature withdrawal penalty if you are not age 59½, and the money will no longer be earmarked for your retirement in a tax deferred account,” Ray LeVitre, a certified financial planner and author of 20 Retirement Decisions You Need to Make Right Now warned.
Since you probably don’t want to take a big tax hit, you’ll likely want to choose whether to keep the cash where it is, roll it over into a new plan or move the money into an IRA. Here are the pros and cons of each option.
Leaving your 401(k) with your old employer
Just because you’ve moved on to new opportunities doesn’t mean that your retirement plan has to go with you. You can keep your 401(k) right where it is with your old employer. “If your old company’s plan is a good one with solid, low-cost investment options this can be a good choice,” Wohlner said to Mic.
The pros of leaving your 401(k) where it is: There’s no action required on your part, and you don’t risk accidentally triggering a penalty for withdrawals if you don’t do the rollover the right way. You may benefit from lower fees with 401(k) investing since “many corporate 401(k) plans have negotiated fees that amount to buying ‘wholesale,” as Scott Dingwell, head of participant communications within BlackRock’s U.S. and Canada defined contribution group, told MarketWatch. You may also be able to get free advice from retirement consultants, which wouldn’t be available with an IRA.
Other perks of a 401(k), relative to an IRA, include stronger protection from lawsuits, the ability to borrow against the money in your 401(k) without triggering penalties and the ability to withdraw money during retirement earlier. While you must wait until you are 59½ to access funds in an IRA, you can begin 401(k) withdrawals after 55 if you retire.
There are downsides too: Your investment options may be more limited. “Most employer-sponsored plans offer about 20 investment options.” LeVitre said. But, if your 401(k) has a good array of options, you’re happy with the fees and access to advice and you don’t feel like handling a lot of paperwork, leaving your 401(k) where it is could be a great choice.
Moving your 401(k) to your new employer
You can still benefit from the negotiated fees and advice that comes with a 401(k) without having to keep your account with your old employer — as long as your new employer offers a 401(k) as well. You can simply move the money from your 401(k) at your old job to your 401(k) at your new job.
“Moving the money to a new employer’s plan can be a good option if the investments are solid and costs are reasonable,” Wohlner said. “This can also be a good way to consolidate 401(k) accounts giving you one less account to worry about.”
You’ll get largely the same benefits from moving to a new employer’s 401(k) as you would by keeping the plan with your old employer. But another big benefit, according to LeVitre: “your old and new retirement money will be consolidated in one retirement account.”
The downside: You may have had different investment options at your old employer versus your new one, which would give you more opportunities to pick different investments. “Limited investment options and diversification,” are a con of rolling your plan over, LeVitre said.
Rolling your old 401(k) over to an IRA
Moving your 401(k) into an IRA can provide different advantages, and as long as you roll over your 401(k) into a traditional IRA — aka not a Roth — you won’t have to pay any taxes when you switch your account.
“Rolling to an IRA makes sense if you are seeking a broader range of investment options than a 401(k) plan might offer,” Wohlner said. For example, with a Fidelity IRA, you can choose from over 10,000 mutual funds, and just about any individual stock, bond (or bond fund), annuity or ETF.
“If you roll to a rollover IRA, use a discount brokerage firm like Fidelity, Schwab or TD Ameritrade where there is a giant line up of no-load mutual funds from hundreds of different fund companies to choose from,” LeVitre advised. You may even be eligible for a cash bonus if you roll your old 401(k) into an IRA. For example, TD Ameritrade is offering $100 if you roll over a $25,000 401(k) or $600 for a $2500,000 rollover.
You may also have more flexibility in how your investments are managed. “Investors can make changes to their investments if they have under performing funds,” in an IRA, LeVitre said. “401k plans are slow to do this.” If you use a rollover 401(k), you also have the flexibility to convert your account back to an IRA if you want to.
However, he also pointed out one key downside to rolling over your money into an IRA: You have to open the IRA account and manage it going forward. And because you are picking your own options, you need to be careful about any fees that might be charged for mutual funds or stock purchases.
But if you want the extra flexibility, it can be a smart choice. Follow this guide to opening an IRA to get you started, and these beginner’s and more advanced guides to investing — for some tips on where to put your money, exactly, and how to cut down on fees.
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