The average millennial changes jobs four times before they reach the age of 32. Generally speaking, this is a great thing from a financial perspective- salary tends to go up whenever you change jobs.
There are a few situations that can arise when we hop from job to job, though. For example, what should you do with your 401(k) once you leave a job behind? Too often, this step gets lost in the shuffle, and it can be easy to lose track of these accounts if you aren’t careful. So, what should you do with your employer-sponsored retirement account once you leave?
There are typically four options that you can pursue. There’s no universal right or wrong answer here (although one option is significantly worse than the others). But, the most important thing is to develop a system to keep track of these accounts as you move from job to job. I have a dedicated framework that can help with this- and I’m sharing it for free on my webinar on March 7. The bottom line- whatever you do, make sure you are able to keep track of where all of your retirement accounts are!
With that being said, let’s discuss the four options in detail.
The Two Not-So-Good Options
Your first option is to cash out your 401(k). As in, when you leave your current job, you technically can withdraw all of the money from your 401(k) to spend it today.
That being said, this is generally a terrible idea. Retirement accounts should be kept until you’re ready to, you know, retire. And, you’ll pay a hefty tax penalty by cashing out of your 401(k) early. Just because it’s technically one of your four options, doesn’t mean you should actually do it.
Your second option is to leave it with your old employer. There are some employers that force you to move it to an IRA if it’s a small account, but in most cases you can leave your old 401(k) with your old job.
That being said, there are a few reasons I typically don’t recommend this approach:
- This is probably the easiest way to lose track of your account. If you leave all of your 401(k)s at old jobs, it can become difficult to monitor all of them. And, of course, you really should be keeping an eye on your investments over time and adjusting them as you get closer to retirement. As you have more and more 401(k)s, it can be harder to keep tabs on all of your different investments if they are scattered across account with your old employers.
- Typically, employers charge fees on 401(k)s for people who are no longer employed with their company. Why pay that fee, that you aren’t getting any service for, if you don’t have to?
If your old 401(k) has great, low cost investments, it might not be a bad idea to keep your account there, but that generally is the only time I recommend this.
The Two Better Options
Two options down, two to go. And luckily, these options are typically better.
Your third option is to consolidate your old 401(k) into your new one, if your new employer will let you. The idea here is simple- why have two accounts to keep track of when you could combine them all into one account? Moving your old 401(k) balance into your new job’s 401(k) is a great way to streamline your accounts.
This doubly goes if the fund options in your new 401(k) are good ones. If you have good investment options that have low fees associated with them in your new 401(k), combining the two accounts is a no brainer. You’ll be limited to the funds available in your company’s plan, but if they’re good, that might not matter too much.
Unfortunately, many 401(k)s use high fee accounts that can really eat into your retirement returns over time, and you aren’t getting anything in return for the fee you’re paying. Which leads us to option four:
You can move your 401(k) into an IRA. To do this, you’ll need to open up a brand-new IRA for yourself (unless you have one already, of course), and then request your former employer to transfer the balance to your new IRA. You’ll then need to select the investments you’ll want to use in your IRA, and monitor their performance over time.
A few notes here:
- When you request your old employer to move the funds to your IRA, make sure they know that you’re moving it to an IRA. Moving a 401(k) to an IRA is not taxable, but if they think you are just withdrawing your 401(k) to your bank account, you’ll need to pay a penalty to the IRS. So, make sure they address the transfer to your IRA.
- Make sure the account is a Traditional or Rollover IRA, not a Roth IRA. Transferring a 401(k) to a Roth IRA will cause you to be taxed on the entire balance of the account. This can be beneficial for some people, but you definitely want to consult with a financial planner before you do this. The key point- make sure that you don’t open up a Roth IRA by mistake!
- One of the benefits of moving a 401(k) to an IRA is that you have full freedom over the investments in the account. You aren’t limited to a few funds in your 401(k), you can choose anything. But, taking this approach means that you’ll need to screen your investments and rebalance your accounts over time. I’d be happy to chat about this if you have any questions about how to do this.
How to Decide between Consolidating and Transferring to an IRA?
So, let’s take it for granted that you’re trying to decide between the last two options- combining your 401(k)s, or moving your old 401(k) to an IRA. How should you go about making this decision? A few key things to consider:
What are you Paying in Fees?- there are some great 401(k)s out there, but unfortunately, many of them aren’t so great. Many 401(k) accounts only have a few funds to invest in, and they tend to have high fees associated with them.
Use a site like www.personalfund.com to evaluate how much you are paying for fees in your 401(k). If your new 401(k) has a lot of low fee options, it might make sense to combine. If you have a lot of high fee options, it probably makes sense to go with the IRA.
Do you Need Help? Do you feel ok self-managing your investments, or do you want the help of a professional? Most financial planners don’t provide direct investment advice on 401(k)s (although I do!), so if you want some help with your investments, usually you’ll need to move it to an IRA. But keep in mind, that will come with an extra cost.
On the other hand, if you feel confident managing your investments yourself, you could pick either route. It’s just a matter of which funds you’d like to invest in. Speaking of which…
What Funds are Available? As I’ve alluded to multiple times, 401(k)s typically provide some convenient funds to invest in, but they tend to be limited and higher in cost. If you want a more extensive investment option, including stocks and index funds, you should probably move to an IRA.
There’s No Universally Right Answer
Ultimately, when you review the items listed above, you might find that you probably can’t go wrong between options 3 and 4. It all comes down to personal preference, and how much you care about investment options and fees. Ultimately, do your homework, and you should be able to sleep soundly with your decision.
And if you have further questions about retirement preparation, sign up for my webinar on March 7th to discuss these strategies in more detail!