Changing jobs? One of the things you’ll have to consider is what to do with your workplace retirement savings plan. The good news is that 401(k) plans are usually portable. However, that doesn’t necessarily mean you have to roll your existing account into your new employer’s plan.
Here are five ways to handle your old 401(k):
- Leave your money in your former employer’s plan. If you like the investment options in the plan and your former employer allows it, you usually can leave the plan where it is. Any earnings will continue to grow tax-deferred, and you’ll pay no taxes of any sort on the account until you start making withdrawals. If you leave your 401(k) plan in place, you probably still will have the option of rolling the plan over to an individual retirement account (IRA) or a new employer’s 401(k) plan in the future.
However, you won’t be able to continue to contribute to a plan left at your former employer. Also, if your old employer should change plan providers in the future, your plan’s costs (that is, administrative and management fees) may change. In some cases, your investments may be rolled over into cash or a cash-equivalent investment, such as a money market fund or short-term Treasury bills, until you select a new asset allocation. Because the return potential of a cash-equivalent investment is generally lower than for a diversified portfolio, you could lose out on potential returns during that time period. Holding multiple retirement accounts can also be a headache when you reach age 70½ and typically must begin taking an annual required minimum distribution (RMD) from each account—if you make a mistake and forget to withdraw from any one account, you will be liable for a tax penalty on the amount not withdrawn. Consolidating your accounts into one can make managing them easier.
- Roll your money into a new 401(k) plan. Your new employer’s 401(k) provider may allow you to roll over your existing retirement savings into your new plan. This can be a good option, assuming you like the new plan’s features, costs and investment choices. Any earnings will continue to accrue tax-deferred, and RMDs may be delayed beyond age 70½ if you’re still working. Some 401(k) plans allow you to borrow from them. Meanwhile, assets in a 401(k) plan are typically protected from claims by creditors. However, before you make a decision, make sure your new employer’s plan has a satisfactory range of investment choices, and that its fees and expenses aren't higher than for your old plan. Also, remember that rolling over company stock may have negative tax implications.
- Roll your money into a traditional IRA. Rolling your old 401(k) into a traditional IRA may give you more choices and flexibility. Because IRAs are not employee-sponsored, you won’t have to worry about making changes to your account if you change jobs again. An IRA provider may offer low-cost products, such as exchange-traded funds (ETFs), or additional services, such as investing tools and guidance, that aren’t available in your employer-sponsored plan.
However, unlike with a 401(k), you will be required to take RMDs at age 70½, even if you’re still working. IRAs generally offer fewer protections from creditors than 401(k)s. Also, if you roll pre-tax 401(k) funds into a traditional IRA, you may not be able to convert them back into an employer-sponsored retirement plan. Also, if you decide to open an IRA, be sure to specify how your money should be invested—until you provide instructions, your money may remain in cash or a cash-equivalent investment.
- Roll your money into a Roth IRA. A Roth IRA is different from a traditional IRA in that potential earnings grow tax-free, not tax-deferred. That means when you withdraw the money after age 59½, you won’t pay any additional taxes on it. You’re also not required to take RMDs at 70½. However, you can’t invest pre-tax money in a Roth IRA—so if you roll traditional 401(k) assets into a Roth IRA, you will have to pay taxes at the time of conversion (you can, however, roll a Roth 401(k) into a Roth IRA tax-free). Also, depending on your annual income,¹ you may not be eligible to invest in a Roth IRA.
- Cash out. It may be tempting to take the money and go, but that’s usually a bad move. If you cash out your 401(k), any taxable portion of your distribution is subject to a mandatory withholding of 20% for federal taxes. Unless you move your money into a qualified retirement plan within 60 days, it will be taxed as ordinary income. State income tax may apply, too. If you’re under age 59½, you may also be subject to a 10% early withdrawal penalty. It’s not just taxes: You’ll also miss out on the potential growth that comes from keeping the money invested long term.
Bottom line: When it comes to your old 401(k), you’ve got choices. Be sure to compare the pros and cons before making a decision.
1 In 2017, you can contribute to a Roth IRA only if your modified adjusted gross income is less than $133,000 a year (single filer) or $196,000 for married couples filing jointly.