Whether you’re making a career change, retiring, or getting a new job for some other reason, managing your 401(k) plan may be at the bottom of your to-do list. However, determining what to do with a 401(k) plan with a former employer is an incredibly important decision that must be carefully considered.
When leaving one employer and starting with another, there are typically three workable opportunities for ensuring the continued growth of your retirement funds. One option is to leave the funds and investments where they are, in your former employer's retirement plan. Another option is to rollover your funds and investments from your former employer's retirement plan to your new employer's retirement plan. Finally, you may be able rollover the funds and investments in your former employer's retirement plan to your own IRA.
Each option has its own set of advantages, and potential disadvantages. Understanding which option offers the most advantages and aligns with your next chapter in life is the first step. Let's explore the three option in more detail.
Leave Your Old 401(k) Alone
If you're satisfied with the investment options and services provided by your current 401(k) provider, leaving it untouched can be convenient. You don't have to deal with signing and sending any forms with your I.D. or other documentation, changing your investments when the funds reach the new 401(k) plan, and additional tax forms when it comes time to file your tax return.
All 401(k) plans are different, and will offer different investment option and have different fees. Your old 401(k) plan may have investments that you prefer and those investment may not be offered to new participants anymore, meaning you could be grandfathered into investments and fee arrangements that are more beneficial for you when compared to other 401(k) plan options.
Depending on the employer's plan features and rules, your old 401(k) plan may offer the option to take loans from your retirement savings. There are specific rules on amounts and repayment of the loan, but you at least have a loan as an option should you have an emergency or other need for some temporary funds. IRAs do not offer the option to take loans, so if you rollover the 401(k) to an IRA you would lose any ability to take out a loan. Your new employer's 401(k) plan may not offer the ability to take out a loan, so that is something to find out and consider when making your decision.
One of the most important features of many employer-sponsored 401(k) plans is strong creditor protection. In case of bankruptcy or legal judgments, your 401(k) assets are typically shielded from creditors. The level of creditor protection for IRAs varies depending on state laws. In some states, IRAs may not have the same level of protection against creditors as 401(k)s. With 401(k) plans, the amount of protection is unlimited. IRAs may offer some creditor protection, but it varies by state, so it's very important to look at your state laws in this regard. More on this particular subject below. For now, it's important to note that protections can vary depending on state laws, the type of bankruptcy, and specific circumstances.
Rollover Your Old 401(k) Into Your New 401(k)
If you don't want to lose some of the benefits of 401(k) plans mentioned above, such as strong creditor protection, consolidating your retirement accounts by rolling over to your new employer's 401(k) plan can simplify your account management. You'll have only one 401(k) plan to select investments from, one plan you receive statements on, and one plan that you'll have to think about withdrawals and required minimum distributions (RMDs) from when in retirement.
If your former employer's 401(k) plan didn't offer an option for loans, it's possible that your new employer's 401(k) plan could offer that option, which might be useful in emergencies.
Rollover Your Old 401(k) Into an IRA
Rolling over your 401(k) to an IRA presents a few advantages. Most 401(k) plans (though not all) offer only specific investments options. IRAs generally offer a wider range of investment choices, allowing you to tailor your portfolio to your preferences and risk tolerance. The wider range of investment options available in IRAs may also have lower fees than the investment options in 401(k) plans, especially when the 401(k) plan only offers mutual funds and IRAs can have generally lower cost ETFs, but also lower cost mutual funds.
Having your retirement investments in an IRA also provides more flexibility and customization. Rather than having your 401(k) invested in only one mutual fund (or maybe two), with an IRA you can invest in multiple mutual funds, ETFs, and even direct stocks and bonds. You can also change the allocation of your investments and rebalance at any time.
If you already have an IRA, rolling over your old 401(k) to an IRA could allow you to consolidate your retirement investments into one retirement account, simplifying the management and tracking of your investments, especially when it comes time for RMDs during retirement.
Making a Decision
In making your decision, be sure to consider all the advantages and disadvantages of each option discussed above, as well as other factors such as the investment options, fees, your comfort level with managing your investments, and any specific financial goals you have.
Assessment
As you work toward making your decision, first read through the new 401(k) plan’s agreement. This will help you understand whether your new employer’s plan accepts rollovers, as some do not. Also, your new employer may have a waiting period in place, meaning that you may need to wait before rolling over funds. The plan's agreement will also let you know about the other features of the plan that might be available, such as loans. Ultimately, plan sponsors maintain the membership guidelines. In some cases, your former employer’s plan may allow the sponsor to cash out the account when you end your employment. Keep in mind that withdrawals could trigger income taxes and a 10% penalty.
Next, gather any appropriate account statements and contact details. When you signed up for the plan, you may have selected both a traditional 401(k) and a Roth 401(k), but keep in mind that these are two separate accounts. Traditional 401(k) contributions are not taxed but are subject to penalties in the case of early withdrawal. Roth contributions, on the other hand, are taxed, but certain withdrawals have no adverse effect as long as the distribution qualifies according to the IRS.
It’s a good idea to meet with a financial advisor before starting the process. You‘ll want to choose the right type of retirement account and avoid paying taxes or penalties for potentially choosing a plan that isn’t right for you. For example, if you decide to roll your 401(k) into a Roth, you should prepare to pay taxes on the full amount.
Be Aware of Financial Precautions
Depending on the duration of your previous employment, it may be worthwhile to check the associated vesting schedules. Vesting schedules are tied to the employer’s contributions and determine the amount and date when the employer’s contributions are legally yours. Your own contributions are fully vested from day one.
Age is another contributing factor when deciding how to approach a former employer’s 401(k) plan. For instance, if you quit a job, are laid off, or are fired the year you turn 55, you may withdraw funds penalty-free from the 401(k) plan established through that employer only. If you choose to roll the funds over into another 401(k) plan or an IRA, you will need to wait to withdraw those funds until the age of 59½ to avoid the 10% withdrawal penalty. In addition, this penalty-free withdrawal does not apply to 401(k) accounts established through previous employers; it only applies to the account established with the employer you leave when 55 or older.
Financial Planning
Whether you leave your investments where they are or transfer from one account to another, it's a good idea to talk with a financial advisor. Having investments in more than one account can make your investment portfolio more complex. A financial advisor can help you determine if your investments are helping you work towards achieving your goals while maintaining your risk tolerance, or what you should reallocate your investments to so that you have a better chance of achieving your goals.
Moving funds and assets from one retirement plan to another can be a tricky process, and, if it's not done properly, could result in some undesired consequences such as a large tax bill. Working with a financial advisor can be beneficial as they can help guide you through the process by reviewing your previous employer’s plan, weighing the benefits of your new employer’s retirement plans, and then making sure right tasks are executed properly.
Individual circumstances play a significant role in determining the best retirement savings vehicle for you. If you’re unsure about which options may be right for you, consulting a financial advisor can help you navigate these complexities so you can help ease your concerns, help you make an informed decision that aligns with your overall retirement strategy and personal circumstances, and avoid costly mistakes. That's one of the things Escient Financial is here for, so go ahead and...
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as investment, tax, or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Digital assets and cryptocurrencies are highly volatile and could present an increased risk to an investors portfolio. The future of digital assets and cryptocurrencies is uncertain and highly speculative and should be considered only by investors willing and able to take on the risk and potentially endure substantial loss. Nothing in this content is to be considered advice to purchase or invest in digital assets or cryptocurrencies.
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