What to Do with a 401(k) After Leaving a Job
Key Points – What to Do with Your 401(k) After Leaving a Job:
- Leave the 401(k)
- Roll the 401(k) Over to an IRA
- Roll the 401(k) Into Your New 401(k)
- Convert the 401(k) to a Roth IRA
- Cash it Out (Generally Not Advised)
- 4 minute read
What to Do with a 401k After Leaving a Job
Have you ever left a job where you were actively saving in a 401(k) account? You may be wondering what your options are for that 401(k).
Depending on your former employer’s plan, you may be losing some of your account balance that was not vested. That means some money in the account wasn’t technically yours until you worked there for a specified period of years. Usually, the vesting requirements only apply to the employer contributions and not what you saved to the account. Regardless of whether or not your old 401(k) is fully vested, you have several options at your disposal when you leave a job.
Leave the 401(k)
The first option we will discuss is to do nothing. You can choose to keep the 401(k) account through your old employer where it is. While you will not be making or receiving any new contributions to the account, you can leave the old 401(k) account where it is. You can continue to manage the investments just like you were while working for your former employer.
On the “plus” side, this option may be the easiest because it requires the least amount of work on your part, which is to say, no work at all. On the other hand, it is quite common (and surprisingly easy) for people to forget about these old, abandoned 401(k) accounts, and forget to manage the investments over time.
For example, you leave your old 401(k) account where it is, start a new job with a new 401(k), and over time, you start to forget to regularly go back to the old 401(k) account and rebalance the investments. We previously wrote a piece on rebalancing your 401(k) and why it’s an important strategy. Click here to read that post.
Roll the 401(k) Over to an IRA
The second option is a fairly common strategy used by people changing jobs. Roll the 401(k) account into an Individual Retirement Account (IRA).
When you separate service from your employer, your 401(k) vested portion can be transferred out of the 401(k) and into an IRA. You or your financial advisor can then manage that account.
One of the benefits of transferring your 401(k) to an IRA is that there are typically many more investment options to choose from. For example, most 401(k) plans offer maybe 10-20 mutual fund options.
Often, you’ll find target-date funds in a 401(k), which we previously wrote about here. With an IRA, you can invest in individual stocks of companies, exchange-traded funds, even alternative assets like precious metals and real estate.
While it’s nice to have options, sometimes having too many options can lead to problems, such as paralysis by analysis or choice overload. It is important that when rolling a 401(k) into an IRA, a direct transfer, or trustee-to-trustee transfer, is done. This is where the check from your old 401(k) is made payable to your new IRA and not made payable to you.
Roll the 401(k) Into Your New 401(k)
A third option is to roll the old 401(k) into your employer’s new 401(k) plan. Some employers may not offer this as an option, so you will need to check with your human resources department or the new 401(k) plan administrator. If your employer’s new 401(k) plan does allow you to roll money in, they can help facilitate the rollover.
The vested portion of your old 401(k) is simply moved into your new 401(k) plan. If your new plan has relatively low fees and a good variety of investment options, this may be a good way to go. While taking a loan from your 401(k) account should typically be avoided, sometimes 401(k) plans will have loan provisions that IRAs do not, so there may be some additional future flexibility with the 401(k)-to-401(k) rollover.
Convert the 401(k) to a Roth IRA
You could also choose to convert your old 401(k) to a Roth IRA. This is similar to rolling the 401(k) account to a Traditional IRA in that you are using a direct transfer.
However, the 401(k) portion converted to a Roth IRA is generally fully taxable as ordinary income. This may be a good option for you to consider if you find yourself in a lower tax bracket during the year you are changing jobs, for example, taking some time off before starting a new job, resulting in a loss of income for that year.
JoAnn Huber discussed how Roth conversions work on a podcast with Dean. Find the episode and show notes here.
Because this option may lead to a tax liability, it is best to consult with a qualified tax professional before converting your old 401(k) account to a Roth IRA.
Cash it Out (Generally Not Advised)
We saved what is probably the worst option for last because it goes against the conventional wisdom of sound financial planning, and that is to cash out the 401(k). Generally speaking, when you cash out an old 401(k), the withdrawal is considered a taxable event, meaning you may wind up owing tax on the amount withdrawn.
In addition, if you are withdrawing from the 401(k) before the age of 59 ½, you may owe a 10% early withdrawal tax. Because of the possibility of a significant tax hit, and a smaller retirement nest egg, cashing out your old 401(k) is generally advised against. Again, it is best to speak with a qualified tax professional before taking such action.
What to Do with Your 401k After Leaving a Job
Because you have so many choices available to do regarding your old 401(k) account, it may be beneficial for you to consult with your financial planner and qualified tax professional.
If you are thinking about a job change or have recently left your employer and would like to get in touch with us to discuss the options available to you, you can schedule a consultation with us by clicking here.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.