What happens to the money in your company retirement account when you leave your job?
Does it have to stay there? Do you lose any of it? Can you take the money with you? If so, what are your options and how do you know which one to choose?
These are all questions that you’ll likely have to navigate at some point in your life, and in this post we’ll dive deep into what your options are, how to decide on the right one for you, and how to avoid some big potential pitfalls.
Four Things You Can Do with Your Old 401(k)
The good news is that the money you saved is still yours no matter where you go. The only question is what to do with it now. Here are your four main options.
Option #1: Keep the money in your old 401(k): Depending on your account balance and the specific terms of your 401(k), you may be forced to move the money (more on that below). But in most cases you will have the option of simply keeping the money right where it is.
Option #2: Move the money into a new 401(k): If you’re starting a new job that also has a 401(k) or other company retirement plan, you can likely move the money from your old 401(k) into the new one. You’ll just need to check with your new plan to make sure it accepts transfers from other plans.
Option #3: Roll the money into an IRA: You can also transfer the money into a new or existing IRA. If you have a traditional 401(k), you’ll likely want to transfer the money to a traditional IRA in order to avoid taxes. Similarly, money within a Roth 401(k) would be transferred to a Roth IRA.
Option #4: Withdraw the money: You are allowed to withdraw the money from your 401(k) when you leave your job, though this typically isn’t a good idea. Unless you’re already 59-1/2 or older, the entire withdrawal will be taxed as income, and you’ll be hit with a 10% penalty on top of that — plus the money will no longer be invested for retirement. So this usually isn’t the best move.
How to Choose the Right Option for You
Any of those first three options could be the right choice depending on the specifics of your circumstances. Here are some things to consider when making your decision.
401(k)s are notorious for having lots of fees. And since cost is one of the biggest obstacles to investment success, this is a great opportunity to make sure your money is in an account where the fees are minimal.
To be honest, this is a big reason why transferring the money to an IRA often makes sense. You don’t have much control over the fees your 401(k) charges, but you absolutely have the option of using a low-cost IRA provider.
The flip side is that in some cases your employer plan may give you access to lower-cost funds than you could use yourself. A good example of this is the government’s Thrift Savings Plan (TSP), which offers some fantastic, low-cost funds you won’t find anywhere else. In that kind of situation it can make a lot of sense to stay put.
Here are a few specific types of fees to watch out for.
- Administrative fees: The worst 401(k)s charge all kinds of administrative fees for things like account maintenance, investment management, legal services, and more. You can find these fees laid out in your 401(k)’s summary plan description, or you can ask your HR representative for a list of all fees associated with the plan.
- Expense ratios: All mutual funds and ETFs have something called an expense ratio, which is the fee charged for managing the investment. It’s calculated as a percentage of your money within that investment and is an ongoing cost you have to pay. If your employer plan only offers investments with high expense ratios, that might be a reason to use an IRA instead.
- Other fees: Honestly, there are any number of other fees your plan might charge, so be on the lookout. In general, the less you have to pay the better.
If you’ve done the work to create an investment plan that meets your personal needs, you’ll have a good idea about the kinds of things you want to invest in.
So the big question here is which of the options above makes it as easy as possible to choose the investments you want?
If you’re 401(k) has them, then great! Using that might be the easiest route. If not, it might make sense to move the money to an IRA where you have full control over what you invest in.
The more accounts you have, the harder it is to manage everything. This isn’t about being lazy or anything like that. Making it easy to both implement your investment plan and keep it on track makes it more likely that you’ll actually reach your investment goals.
Unless the other factors heavily favor complexity, I would err on the side of having as few accounts as possible.
Money within a 401(k) is fully protected against bankruptcy and lawsuits, while the protection offered to money within an IRA varies from state to state. This could come into play if you have a large balance in your retirement plan (typically $1 million or more), and you either:
- Have a significant amount of debt, or
- Are susceptible to being sued, such as if you own a business.
To be honest, this probably shouldn’t be a big concern for most people. But if you fall into the categories above, you should consult your state rules about IRA protection and factor them into your decision.
Pitfalls to Avoid
Assuming you’ve considered the factors above to decide what you want to do with this money, here are a few things to watch out for that could throw a wrench into your plan.
Time limits: In most cases you’ll be allowed to keep the money in your old 401(k) for as long as you want, giving you plenty of time to make your decision. But in some cases your plan may force you to make a decision within a certain time period or else it will simply send the money directly to you. Since that would come with taxes and penalties, you’ll want to double-check whether your plan has any time limits so that you can be sure to work within them.
Taking the money directly: If you decide to move the money to either a new 401(k) or an IRA, you’ll want to do what’s called a direct rollover. That transfers the money directly from account to account without you ever having to take possession of it.
You do have another option if you’re transferring it to an IRA, which involves having the money sent to you first and then you contributing to the IRA yourself. But there are two big problems with this option:
- You only have 60 days after receiving the money to deposit it into an IRA before it’s considered taxable income and subject to penalty.
- Your employer is legally obligated to withhold at least 20% of the money for tax purposes. But you have to deposit the full amount into an IRA to avoid taxes and penalties, so you’ll have to make up the difference from other sources.
A direct rollover avoids all of that complication. Here’s more info on how to do a 401(k) rollover.
Vesting: This isn’t exactly a pitfall, but it’s something to be aware of. Some companies have vesting schedules that mean you might not yet be entitled to all of the employer contributions made to your 401(k). You will always get 100% of the money you saved personally, but just be aware that in some cases you won’t receive your entire account balance.
Don’t Let It Linger
Whatever decision you make, I would encourage you to make it relatively soon after you change jobs.
This isn’t to say you should rush it. You should absolutely take the time you need to make the right decision for you and your family.
But taking care of this quickly makes it more likely that you’ll actually make the right decision instead of letting an old account linger and potentially be forgotten.
After all, this is money that can help you reach your biggest financial goals. Make sure it’s being put to good use!
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.