As you say goodbye to your old employer, you’re probably experiencing a variety of emotions. There’s a sense of excitement for what’s to come but perhaps some nervousness too. You’re faced with so much change that it’s common to forget about your 401(k) or 403(b) that you’re leaving behind with your old employer. But because this can make up a significant part of your retirement savings, it’s important to look at the options you have and pick the best one for your situation. Here are some choices to consider.
Leave It Where It Is
Pros: Most employers, but not all, will allow you to keep your 401(k) in their plan after you leave. Leaving it where it is, allows your money to continue to grow tax-deferred (or grow tax-free in the case of a Roth 401(k)), and can possibly give you access to institutionally-priced investment options.
Cons: The downside is that you are no longer able to contribute to an old 401(k) and you are only limited to the set of investment choices within the plan. Depending on the plan, it can also have higher than average fees than other options that are available. And finally, the plan may automatically distribute the funds to you or roll it into an IRA if you balance is less than $5,000.
Roll It Into Your New Employer’s Plan
Pros: By rolling your old 401(k) into your new 401(k) it’s easier to manage your retirement savings by having only one employer plan. If your new plan offers great investment options and low fees this may be a great choice for those who want the simplicity of one plan. Another benefit is that if you’re approaching age 70 1/2 with no plans to retire anytime soon, a 401(k) allows you to put off taking Required Minimum Distributions (RMDs) while you’re still working.
Cons: Not all employers will allow a rollover into their plan so be sure to review the plan rules. Also, you don’t want to go into a plan that has limited investment options or has a lot of fees so be sure you know exactly what you’re getting into before you decide to combine your old plan with your new plan.
Roll It Into An IRA
Pros: Rolling your old 401(k) into an IRA gives you a lot more control in choosing what you are able to invest in and who you can invest with as an IRA gives you access to so many investment options. Another benefit is IRAs give you the flexibility to take penalty-free withdrawals in the case of first-time homebuyers or higher education expenses. And finally, you’re able to combine it with an existing IRA you may already have in place and continue to make contributions (depending on your income). Ultimately this option is best for those who want to avoid high 401(k) fees or want more control and flexibility.
Cons: Once you reach age 70 1/2, regardless of whether you’re retired or still working, you are required to take an RMD from your IRA every year. If you don’t choose to do a Direct Rollover from your old 401(k), your employer may withhold 20% so always ensure you choose the Direct Rollover option.
Cash It Out
Cashing out should be avoided unless your need for cash is critical. If you are under age 59 1/2, withdraws from a retirement plan or IRA are subject to a 10% early withdrawal penalty plus those funds will be considered ordinary income meaning you will pay taxes on it subject to your tax rate, or potentially bumping you up to a higher tax bracket (this penalty won’t apply to 401(k)s if you’re 55 or older in the year you stopped working for your former employer).
If you are under 59 1/2 and absolutely need the cash, take only what you need to avoid as many penalties as possible or until you find other sources of cash.
Regardless of what you choose to do, it’s so important to make an informed decision. Look at the 401(k) rules, compare fees and expenses, and consider the potential tax impacts. And as always, it never hurts to talk to your financial professional so they can help you evaluate the various options.