Should You Roll Over Your Old 401(k)?

MARK RIEPE: As I’m recording this episode, 2020 is shaping up to be a monumental year in American history. This isn’t a history or political podcast, but the momentous economic events do have ramifications for the personal finances of millions of Americans. One ramification is the relationship between one’s job and the ability to save for retirement.

In the past many companies offered defined benefit plans. In a simplified example, a defined benefit plan generally provided a retired employee a check for as long as the employee lived.

There were three big catches, though.

First, it was the company that held the assets to the plan. If the company didn’t invest the money well, it might not earn enough on those assets to make its promised payments. Second, the company needed to make enough contributions to the plan. Think of these contributions as the amount of savings the company was setting aside.

If the company set aside enough money, and it earned a decent rate of return, then it would be in a good position to make the promised payments to the beneficiaries of the plan.

The third catch was that the assets in the plan weren’t portable. Typically, an employee would have to work for at least 10 years before the employee was eligible to participate in the plan. If the employee left the firm too soon, then the employee didn’t get anything from the plan.

A defined contribution plan like the 401(k) has some similarities to the defined benefit plan. It’s important to make contributions to the plan and it’s important to earn a decent rate of return on those contributions.

One of the big differences is that the employee, not the company, has far more control. Of course, with control comes responsibility. It’s up to the employee to make sufficient contributions and to invest the money wisely.

Another big difference is that the money in a 401(k) plan is portable. That means the employee can take the money with them when they leave the firm. A consequence of this it that the employee has a decision to make, a decision that will perhaps need to be made multiple times over their working life. That decision is what to do with your old 401(k) when you leave your employer.

This decision matters for many people. Schwab Retirement Plan Services found that the average employee expects to change jobs four times over their career. In addition, Schwab finds that for 58% of Americans, their 401(k) is their only or largest source of retirement savings. Americans realize the importance of their 401(k) accounts. Schwab finds that 87% of employees list a 401(k) plan as a “must have” benefit from an employer. Health insurance is the only benefit that rated higher at 89%.¹

I’m Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It’s a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.

This episode is focused on what to do with your old 401(k). By that I mean the 401(k) you had at a previous employer. We picked this topic because there is so much upheaval right now in the labor markets. By that I mean people leaving old jobs and hopefully finding new ones soon. That turnover is going to create a lot of left-behind 401(k) accounts. And we expect this turmoil will continue for years.

A bias that pertains to this decision is the status quo bias.² People prone to this bias don’t make changes to their routine even when their circumstances are significantly altered. Status quo bias creates a sort of paralysis because sticking with what you’ve always done is easier than taking action and changing course. There are lots of things you could do, but you end up doing nothing, which means you passively accept what may be a sub-optimal situation.

This is a meaningful bias. Dan Ariely, is a prominent researcher in behavioral , and he once said, “Few things are as strong as the status quo bias. We look to our past behavior to guide future behavior and rely on habits to get through the day.”

In the context of the 401(k) plan the bias causes people to not do anything with their old 401(k). They just leave it there because that’s the status quo. As it turns out, that may be the right decision, but not necessarily.

Joining me now is Nathan Voris. Nathan is a senior managing director for Schwab Retirement Plan Services. Nathan, I believe we spoke way back in Season 1 when you were a guest talking about practically everything pertaining to 401(k) plans. So welcome back.

NATHAN: Thanks, Mark. Glad to be back.

MARK: If you’re interested in a broader discussion of 401(k) plans and how to use them, just go back to Season 1, Episode 8, I believe, to get a lot of great information. Today, Nathan, the focus on this episode is on figuring out what to do with a 401(k) that you maybe have left over from a previous job. Right now, unemployment is very high. Many people are unsure if they will be returning to their jobs as usual. So let’s walk through a few different scenarios.

First of all, what are your options if you’re not working but you still have a 401(k) from your previous employer?

NATHAN: Yeah, you have a few options. You can either leave it where it is. You know, many 401(k) plans allow you to keep your money in the plan if you’re terminated, so you don’t have to be an active participant or employee to keep your money in the plan. You can also roll that money over to an IRA. And then, lastly, you can take a distribution, so you can cash it out and spend it or put it in a savings account. Typically, distributions come with some tax penalties, depending upon your age.

MARK: And what are the mechanics of doing that? How do you actually get that done from an administrative standpoint?

NATHAN: Yeah, so a rollover is essentially moving the money from one bucket to another, and it’s a pretty streamlined process at this point. So the company that currently administers your 401(k), or wherever that money’s moving from, has some paperwork that you fill out online, and it usually gets transferred pretty seamlessly behind the scenes. So it’s a bucket-to-bucket transfer that can allow you to eliminate the tax consequences and keep the tax-advantaged status of your retirement assets.

MARK: So maybe let’s talk about one of those, which is you’ve switched jobs recently, you’ve got your 401(k) at your old employer, but the new job offers an entirely different plan. What’s the best option there?

NATHAN: Yeah, you know, it’s a tough question, because it’s very individual. You know, the options I just listed, you certainly still have all of those options, but the additional option you have is to roll that old 401(k) into your new 401(k). And so, you know, there’s some analysis that should be done when you’re doing that to determine if an IRA is a better choice or if your new 401(k) is a better choice. And so looking at the fees, looking at the investment flexibility. Are your other outside accounts with your IRA provider already, so can you do some consolidation? There are some things to consider when you’re making that decision if you start a new job that has a 401(k), as well.

MARK: Nathan, a survey I actually saw coming out of Schwab Retirement Plan Services, they’ve surveyed employees and found that when evaluating must-have benefits at an employer, at a new employer, healthcare and a 401(k) plan were actually at the top of the list. So how do you decide if your new employer has got a good 401(k) plan? What should you be looking for?

NATHAN: Yeah, that’s a great question. And you know, I think there’s a few things to look at. One is the flexibility. So does the investment menu have the number of investment options that are appropriate for you? Do they have a brokerage window that allows you to be more flexible if you want to be? What are the fees, both the investment fees but also the administration fees? You know, most 401(k)s have some sort of administration fee that is charged so that the plan sponsor can administer and sponsor the plan. And so those are all things to sort of dig into. So comparing that to what you could get similarly in either your old 401(k) or an IRA is a good place to start.

You know, and it can be dependent upon company types. You know, I had a good friend of mine a couple years ago ask me this very question. And he was leaving a Fortune 50 company that had a $10 billion 401(k) plan, so it was really efficient, low-cost, affordable, well managed. And he was going to a start-up company that had just started their 401(k), so their fees and expenses were a little higher, their investment options were a little bit more expensive. And so, for him, it made sense to roll over to an IRA or to keep it in his old plan, whereas if that were in reverse, it would be a different decision. So it is a real personal decision, based upon a lot of factors.

MARK: So Nathan, let’s talk about a different scenario. This is for people who are temporarily out of work, maybe they’re furloughed. They certainly plan on getting back into the workforce at some point, but they’re not getting the paycheck they used to. They need a source of funds, and they’re looking to their 401(k) as an option. Is that a possibility, and what do you think about the advisability of doing that is?

NATHAN: They certainly can, although we often view that as a last resort, because of some of the issues like taxes and penalties that are associated with taking those types of distributions. The other issue is that you’ve been accumulating those dollars for retirement. And so any distribution that you take early obviously impacts your nest egg, longer down the road. That said, we’re in one of those environments today where many folks are furloughed or are facing some financial hardships, and so we see distributions increasing during this time period.

One of the things I’d mention is that with the CARES Act, which was passed back in March, there is some benefit around the penalties that typically are associated with distributions before 59½. So if you’re facing a coronavirus-related hardship, and you take a distribution from your 401(k), those penalties are waived. So if you are facing that kind of hardship, there is some relief there—even though you may want to check with your tax advisor prior to taking a distribution to ensure it qualifies under the CARES Act. So there is some sort of relief in the short term, but overall, we typically advise folks to use that as a last resort.

MARK: So is that sort of cashing out or taking a distribution, is that an all or nothing thing, or is it possible to do that just with a small portion of the balance that you have in the plan?

NATHAN: It depends on the plan sponsor. So each plan has different payout provisions written in their plan document. So you see some that allow partial distributions and then others that only allow a lump sum. So that’s one of those things that you’ll have to look into that’s a plan-by-plan issue.

MARK: Nathan, let’s talk a little bit about loans. How does a … if you’re in a cash-strapped situation, what’s the advisability of, say, a distribution versus just taking a loan against your current balance?

NATHAN: Yeah, you know, I think most people, traditionally, start with the loan, with the intention to pay it back over time. And so that is, typically, a place to start. I will say, though, that in this current period, with the relief from the CARES Act, we are seeing more people take a distribution than a loan when faced with that decision because of those penalties not being there as part of the distribution.

MARK: Yeah, it makes a lot of sense. Let’s imagine, though, you do have a situation where you have a loan outstanding and you’ve switched jobs. Are there any complications with some of the rollovers you just described if you already have a loan outstanding?

NATHAN: There can be some complications. Yeah, you took the loan with the intention to pay it back, and so if you leave that employer, you still need to do that. And so often what you’ll see is that when someone does the rollover to their new plan or to their IRA, they pay off the loan in a lump sum when they do that. Some plan sponsors also allow you to pay off the loan even if you’ve left the company. So you can continue to make the payments to pay the loan off if the money is still in that 401(k). And then, unfortunately, what often happens is folks will leave a 401(k), they’ll move it to an IRA or to a new employer, and they actually will default on the loan, and so they end up not paying it back. And that comes with some issues, as well.

MARK: We’ve been talking about rollovers a few different times during this interview so far. I’ve heard the term “indirect rollover.” How is that different from what the kind of rollovers we’ve just been describing?

NATHAN: Yeah, you know an indirect rollover … I talked about that seamless electronic transfer prior, as part of a direct rollover. An indirect rollover is where you take a distribution, so you actually take a physical check, and you have 60 days to find a place for that money. So it’s often used in a scenario where the individual knows they want to roll it over, but they don’t quite know where yet. And so they take that distribution, with that 60-day window. So they have 60 days to transfer those assets to a new account and face no penalties. Generally, the employer will withhold the taxes, the 20% taxes, which is returned as a tax credit for the year when the rollover process is completed. But you’ll have to supply the funds to make up the difference in the short term, so that can be an issue as well. So the rules are a bit complicated. So in most cases, if you do know where the money is going, the direct rollover can be your best option. And if you don’t know, it may be best to just leave the funds in your old plan for the time being—if you can.

MARK: Thanks, Nathan. Let’s talk about, you know, how can people get help? Because we’re talking about maybe you’re furloughed and you still have, you know, your existing plan, moving it to … you know, to a new employer and a new plan, maybe moving it to a brokerage firm and rolling it over into an IRA. What’s the best way to get help given all these different possible decisions that one might make?

NATHAN: Yeah, I mean, the good thing is, is that the help is out there. So one of the core functions of a 401(k) administrator like Schwab RPS is to do exactly that. And that is to help folks make decisions on how they should invest their money, what they should do at retirement, all of those kinds of things. So a good place to start is the company that administers your 401(k). I’d say the other great source is if you have outside assets or checking accounts or savings accounts with a brokerage firm, they have those resources, as well. So tap into the resources that are there with the accounts that you already have, and there’s plenty of help and guidance to put folks where they need to be.

MARK: Nathan, does it ever make sense just to leave the old 401(k) just at your old employer and just, you know, don’t do anything with it?

NATHAN: It can. Yeah, it really can. You know, we see that all the time. Sometimes people like the 401(k) that they’re in, and it’s the low- cost option that has great investment options and good service. And so people will leave it where it is, and in some ways view that as, on some level, some diversification. Although that’s … you know, we know that’s not the true use of that word. But you know, having money in a few buckets, often people like that, and so we do see people leave their 401(k)s at their old employers at times.

MARK: Let’s talk about an option that some more sophisticated investors use, and that’s they’re using a brokerage window with their 401(k) plan assets. So maybe, first of all, if you could just explain what a brokerage window is, and then, secondly, how is that … how are those assets treated during all these different scenarios we’ve been talking about?

NATHAN: Sure. So a brokerage window is essentially a vehicle that allows a 401(k) investor to invest in a broad array of options that ... whereas their core menu is typically limited to some core asset classes and often one mutual fund or collective trust per asset class. So it allows folks to invest directly in stocks, ETFs, an array of mutual funds at a very low cost, oftentimes free in this environment. And so it’s just a great way for folks that take a little bit more ownership of their investing to have the whole array of options available to them. In situations like this, where we’re talking about distributions, it’s not treated very differently. It is still a part of the 401(k) in terms of your tax treatment. So same tax treatment and really not much different than investing in the core menu when you’re talking about taking distributions.

MARK: So a couple more questions here, and then I’ll let you go. We’ve been talking about kind of moving these accounts or moving these balances. Is it the case that these positions that you own in your old account, are those sold and cash is moved, or is the position itself just transferred to the new account?

NATHAN: It’s most often the case that you actually cash out positions and reinvest. You know, there are certain times where maybe you have a company stock or equity in a plan and you could transfer that in kind, but more often than not, it is a cash out and a repurchase scenario. And that … Mark, that’s a great point because that is one of the things that people take a look at, is locking in cost basis and those kinds of things. In a pretax environment that we’re in with a 401(k), a lot of those things aren’t applicable, but it’s definitely something that people keep an eye on.

MARK: Yeah, you’re not being taxed, necessarily, on any gains that are being made. So it doesn’t ... you know, it’s very different when you’re dealing with these tax-deferred accounts, than you’re really ... when you’re dealing with the taxable account, where you’re going to have to pay capital gains. Is that right?

NATHAN: That’s right.

MARK: Last question, Nathan. Let’s say you’re currently employed, you’re enrolled in your 401(k) plan, you have no plans on leaving your current employer, but your employer has stopped offering to match your contributions into the plan. Should you still continue to make your contributions to the plan, even if your employer’s not matching those any longer?

NATHAN: You know, that’s a tough one, and unfortunately, right now, it’s one that we’re facing in this current environment. Many companies are starting to look at suspending their matches. So there are a few scenarios. One is that, if a match is suspended, many participants view that as temporary, and so they continue contributing in exactly the way that they have, in the hopes or with the knowledge that those matching contributions will come back at some point in time. Others may dig in a little bit more and find another bucket of money that they have a preference towards, maybe contribute to an IRA instead of the 401(k), if eligible—whether a traditional IRA or a Roth IRA—if they can based on certain income thresholds.

Some people might look at their HSAs—that’s a health savings account—which can essentially be another retirement account. Because withdrawals for qualified medical expenses from an HSA are always tax-free. But in retirement—if you’re 65 or over—any withdrawals are penalty-free. That means you pay regular income taxes on withdrawals for non-medical expenses, but not an additional penalty—making it essentially like a withdrawal from a 401(k) or traditional IRA.

So you can make those HSA contributions if you’re eligible for that, if you have a high-deductible health plan at work, and you have access to one, and you’re not already contributing up to that yearly limit.

So in other words, there are options. The important thing is, regardless of the match, it’s best to keep contributing toward your retirement in some way if you can. That’s a great one to dig into, I think, with the help and input of an advisor or your existing 401(k) administrator.

MARK: Yeah, and I think at the end of the day, if you still have retirement as one of your goals, which the vast majority of investors do, a 401(k) or any kind of tax-deferred savings account is a great way to do that. And so maybe without the employer match, it’s not as attractive as it was before, but it’s still better than nothing, right?

NATHAN: Absolutely.

MARK: Well, Nathan, this has been a great. Thanks for being with us today.

NATHAN: Glad to be here. Thanks, Mark.

MARK: Nathan provided a lot of food for thought with respect to this decision. If you’re still stuck on what you should do, one technique is to look at what others are doing. Schwab asked 1,000 participants in 401(k) plans what they would do in this situation.

• 48% said they would roll their account over to the plan of their new employer.
• 30% said they would roll it into an individual retirement account or IRA.
• 12% would leave it alone at their previous employer.
• 6% said they didn’t know what they would do.
• And 4% said they would cash it out.

Again, that’s a survey where people were asked what they expected that they would do. It’s impossible for us to determine whether that’s what you should do, but it does give you a sense as to how others are thinking about this decision. It’s also interesting to me that almost everyone felt that some action would make sense—as opposed to letting the account stay behind.

Here’s one final thought. If you’re switching jobs and need to make a decision about your 401(k) account, use this opportunity to review other aspects of how you’re using your 401(k) assets.

There are two big questions to ask yourself: “Am I saving the right amount?” and “Am I investing those assets the right way?”

Because of the status quo bias, there’s a good chance you haven’t looked at your savings rate and investment choices recently. It’s likely that the choices you made when you started working for your old employer aren’t the best options for you today. In fact, the original study that identified the status quo bias was inspired by the behavior of employees in tax-deferred savings plans like the 401(k). Take this opportunity to review those choices and adjust them as needed.

If you’d like to learn more about your options when it comes to saving for retirement, check out schwab.com/retirement. On that page you can find answers to common questions and try different calculators to estimate your retirement needs. That’s schwab.com/retirement.

Thanks for listening. If you’d like to hear more from me, you can follow me on Twitter @MarkRiepe. M-a-r-k-R-i-e-p-e.

If you’ve enjoyed this episode, consider leaving us a rating or review on Apple Podcasts or your favorite listening app.

For important disclosures, see the show notes and schwab.com/financialdecoder.

¹ Schwab 2019 401(k) Participant Survey.

² William Samuelson and Richard Zeckhauser, “Status Quo Bias in Decision Making,” Journal of Risk and Uncertainty, 1988.