According to the U.S. Department of Labor, there are 656,241 defined contribution plans in the United States. 560,241 of these are 401k plans. With over five hundred thousand plans it is no surprise that about 55 million Americans participate in one in order to save for retirement. These plans account for 5.2 trillion dollars in assets.
The Bureau of Labor Statistics released a report showing that on average people hold around 12 different jobs from the age of 18 to 50. Changing employers 12 times or more in a lifetime has the likelihood that a 401k from a previous employer will be left behind when moving to a new job.
What options are available for an old 401k?
Cashing out an old 401k is almost never a good idea and most financial experts would agree. It might be tempting to do this in order to pay off debt, take a vacation or purchase a new car. The issue with doing this is the taxes and penalties that would apply to cash out. If you are younger than 59 ½ a 10% penalty will apply to cash in along with regular tax. Your former employer will withhold 20%. This is for the IRS in addition to the penalty if you are young.
Saving for retirement is never easy. Cashing out an old plan with good intentions to even lower debt is just a bad idea. Retirement assets should never be used for anything but retirement unless it is absolutely the last resort. It doesn’t matter how big or small the 401k amount may be. Taking the money before retirement should not be done.
In addition to getting much less than you put in your 401k when cashing out before retirement, you also will miss the opportunity for the money invested to grow tax-deferred. When investing for retirement, time is good. The more time you have the further a 401k can grow.
Just Leave Your 401k With Your Previous Employer
Leaving a 401k with a former employer is probably the easiest option. However, it may not be the best choice. Leaving it there may depend on the balance in the plan. Some employers, for example, may require a plan participant to have at least $5000 invested for the 401k to remain once employment ends.
In addition to a possible balance requirement to leave an old 401k where it is, some employers may have higher fees for plans that were held by previous employees. You might also miss important plan updates if you are no longer working for the company.
Other problems with leaving a 401k plan with a previous employer include the challenge tracking several different retirement accounts and knowing if you are thoroughly diversified with investments.
You are not able to continue contributing to an old 401k. But you do have the option of leaving it where it is. In my opinion, the largest reason to move an old 401k is to not possibly forget about it and also to have retirement assets in only a few places. It is just much easier to keep an eye on.
Move it to Your New Job
Rolling over an old 401k to a new employer may or may not be possible. A new job that does have the option might make you wait a certain period of time before it can be done. If a rollover from one plan to another can be done, you might have some of the same issues as just leaving it with your old employer.
The 401k at your new job may have higher fees than your old one did. Also, the plan could change to something that is not as good as it was when you transferred your old 401k to the new one. If an old plan can be moved to the new one, there are a few ways it is typically done.
This is done by your old employer transferring the 401k money directly to you. Doing this withholding will apply from the check they cut and penalties could apply if you end up not rolling the entire amount into the new 401k. The previous employer will withhold 20% from an indirect option. You will need to come up with the difference to roll it all into the new 401k until tax time and the 20% will then be released.
A good example to use is if you had $100,000 and chose an indirect method, you would receive a check for $80,000 dollars. You would need to deposit $100,000 into your new 401k. Then, 20% would be released at tax time. If you are not able to make the full rollover of 100k, you would have the 20% withheld and a 10% penalty if you are under 59 ½. Personally, doing an indirect rollover is not a good idea in almost all cases. If you need a short-term loan, you have 60 days to get the money into the new 401k. But beware if you do not get all of the money in the new plan in this time period. The penalties and taxes will apply.
Your previous plan administrator makes a transfer to your new job’s 401k.
Taking these into account I personally know that paperwork gets messed up at brokerage firms and employers. I would just not chance it. Doing an indirect move from one 401k to another is just a headache waiting to happen. The direct method is usually the best option.
I am not a legal expert, but in some states, there may be more protection from creditors to having retirement assets in a 401k opposed to an IRA, which I will cover next. You should have a legal professional look into this if it is a concern.
Roll Over Your Old Plan to a Traditional IRA or Roth IRA
Rolling over an old 401k is the best option in my opinion for dealing with old employer retirement plans. A direct or indirect rollover can be done with this just as a 401k to 401k move.
IRA plans have the benefits of more control and flexibility compared to 401k plans typically. It is common for most 401k’s to have a limited number of investment choices. IRA’s have many more. This allows the possibility of investments that have much lower fees compared to the ones in a 401k. Additionally, if you want professional investment advice, an advisor can work with an IRA. They are not able to monitor 401k’s because they do not have the same access to these.
If you had Roth 401k contributions in your old plan, you can open a Roth IRA and roll the money into it for a plan that was not with Roth 401k contributions, a conversion to a Roth IRA can be made by paying the taxes. You should consult with a professional in doing this if it is something you are considering may be right for you.
What Should You Do with Your Old 401K?
The decision on what to do with an old 401k is an individual one. You can leave it where it is, cash it out or roll it into an IRA. My personal opinion is to roll old 401k’s into an IRA. The chances for better investment options and more flexibility are high. Leaving an old 401k with a previous employer to me is a headache. I like to see most of my retirement assets in only a few places. With the average number of job changes people make these days, leaving old 401k’s all over the place is not a good way to keep track of retirement assets. Moreover, once an IRA is opened you can just move another old 401k into the same IRA again if the time comes. It just makes things much easier.