Here’s the situation; you’ve left your job, found a new one, and are wondering what to do with your previous companies 401(k). It’s a common scenario nowadays; the Bureau of Labor Statistics did a survey of baby boomers and found the average number of different jobs in a lifetime is 12. We’ve all heard about the millennials who change jobs even more frequently. This leads to the situation where you need to figure out which option is best for your old 401(k).
Fortunately, our puppy, Cider, has a few tricks that we can use for guidance.
First and foremost, your retirement money is your money. You can certainly take a distribution and fetch your money. Unless you are in an abnormally low tax situation or have a financial hardship and have no other choice, this option is typically not good. When you take a distribution out of a traditional 401(k), that money will be added to your income for the year and taxed at your ordinary income tax rate. Even worse, if you are under 59 ½, you will most likely be subject to a 10% early withdrawal penalty on top of the income taxes (the IRS does have a few exceptions for this penalty). That makes retirement money a very expensive source of funds during your working years.
Even though you don’t work for the company anymore, most plans will let you keep investments inside of the company’s retirement plan. This is sometimes a great option, especially if you have a good plan. For better or worse, not all 401(k)’s are created equal. Some of them offer a wide variety of solid investments with low administration costs. Others have very narrow, expensive choices. If you are comfortable with your plan and are happy with the investment options and fees, sitting tight is a perfectly fine choice.
Another scenario that you would almost always want to stay in the 401(k) is based on your age when you left the company, specifically if you left after 55 and are still under 59 ½. Before I mentioned that there are a few exceptions to the 10% early withdrawal penalty, the rule of 55 is one of them. If you separate from service “during or after the employee reaches the age 55,” you are exempt from the 10% early withdrawal penalty. The catch is you are only exempt from that penalty in that company plan. If you roll the money to an IRA and then take a distribution, you owe Uncle Sam an extra 10% for no good reason. If you are in this window, and you have any slightest inkling of a notion that you may need money from your old 401(k) before you are 59 ½, you should keep the money in the old plan. Once you hit 59 ½, you are not subject to the penalty anymore, and you can then move it if you want.
Your third option is to do a rollover, either into a new 401k or an Individual Retirement Account (IRA). It’s nice to have money consolidated in one spot. It makes it easier to monitor and manage, with fewer accounts you need to figure out how to invest. Those are the main reasons to consider rolling it into your new company’s 401(k), moving the assets into the same place you will now be contributing. It is especially attractive if your new 401(k) has those solid low-cost investment options I mentioned previously.
You can also roll your previous plan into an Individual Retirement Account (IRA). The IRA is your own personal retirement account, meaning they typically have much more flexibility in terms of what you can invest into compared to a 401(k). That’s a blessing and a curse; while you may be able to screen the thousands of investment options in an IRA to find better choices for you, it can also be overwhelming. The other big blessing and curse of an IRA comes to how you manage it. While you can self-direct an IRA, you can also have it professionally managed.
As an advisor who manages IRA investments for clients, I can tell you I believe professional management provides great value for many, but not all, people. If you do not have the time, knowledge, or the commitment needed to create and monitor a portfolio, rolling to an IRA that is professionally managed might be a good option for you. It comes at a cost, though, and depending on the situation, that cost might not be worth it.
Cider is a mini golden-doodle, and some of these “tricks” came very naturally. Like any dog with Golden Retriever in them, from day one, she wanted to play fetch, constantly bringing over toys to anyone around to get started. Just like with the retirement accounts, though, more often than not, it just wasn’t the right time to play. It took a bit more work to teach her that there may not be immediate gratitude to sit and stay, but like keeping money in the retirement plan, she realizes now the self-discipline leads to better rewards in the future. Finally, teaching her to roll over was more difficult. She didn’t understand the process and instructions right away. Now that she’s got it though, she does it happily with a big smile on her face.
While I tried to present these options in a more light-hearted way by using the family dog, this is a serious decision that you will probably face more than once in your career. If you would like some help talking through the pros and cons of options in specific detail to your situation, Michelle and I would be happy to help you do so.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal, or tax advisor for specific information pertaining to your situation. Investing involves risk including loss of principal. Past performance is not indicative of future results.