Rolling Over Your 401(k): Options and Best Practices
When you leave a job, you may find yourself with an important decision to make about your old 401(k). This employer-sponsored retirement plan has likely been a cornerstone of your savings strategy, but what should you do with it now? Several options are available, each with advantages and disadvantages. Understanding these choices can help you make sound decisions that align with your long-term financial goals.
1. Leave the 401(k) with Your Former Employer
One option is to leave your 401(k) in your previous employer’s plan. This can seem like the easiest path, as it requires no immediate action. Most employers will allow former employees to keep their retirement savings in the plan, provided they have more than $5,000 in the account.
Pros:
Familiarity: You’re already familiar with the plan’s investment options, fees, and structure.
Institutional benefits: Some large employers may offer low-cost investment options or access to institutional funds unavailable to individual investors.
Cons:
Limited control: You no longer have access to new employer contributions, and the investment options in your former employer’s plan might be more limited compared with alternatives, like an IRA.
Higher fees: Some plans charge additional fees to participants who no longer work for the company.
Difficulty managing multiple accounts: Having your retirement savings scattered across multiple accounts can make managing your overall financial picture harder.
2. Roll Over the 401(k) to Your New Employer’s Plan
If your new employer offers a 401(k), you may be able to roll your old plan into the new one. This can be a straightforward way to consolidate your retirement savings.
Pros:
Simplified management: Having all your retirement savings in one account can make it easier to manage your investments.
Cons:
Limited investment options: Your new plan may not offer the same range of investment choices as your old one. You’ll want to do your research.
Administrative hassle: Completing the rollover process involves paperwork and coordination between your old and new plan administrators, which can take time.
3. Roll Over to an IRA
Another popular option—and the one we almost always recommend to our clients—is to roll your old 401(k) into an individual retirement account (IRA). This can give you more flexibility and control over your investments.
Pros:
Greater investment choices: IRAs typically offer a broader range of investment options than most 401(k) plans, including stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
Potential for lower fees: Depending on where you open your IRA, you may be able to access lower-cost funds and reduce administrative expenses.
Tax advantages: Rolling your 401(k) into a traditional IRA keeps the tax benefits intact, and you can also consider converting to a Roth IRA for tax-free withdrawals in retirement.
Cons:
No loan option: Unlike 401(k) plans, IRAs do not allow you to borrow against your balance.
Tax implications: Rolling over from a traditional 401(k) to a Roth IRA will mean paying taxes when you complete the conversion, so it’s essential to understand the tax implications before proceeding.
Potential for higher fees: Depending on where you invest, you might encounter higher management fees in an IRA compared to institutional 401(k) funds. Again, you’ll want to do your research before making the move.
4. Cash Out Your 401(k)
The least favorable option, but still a choice, is to cash out your 401(k). This involves withdrawing the funds, paying taxes, and potentially penalties on the money.
Pros:
Immediate access to cash: This option gives you quick access to your retirement funds, which could be helpful in a financial emergency.
Cons:
Tax penalties: If you’re younger than 59½, you’ll likely face a 10% early withdrawal penalty on top of regular income taxes.
Lost growth potential: By cashing out your 401(k), you lose the long-term compounding growth that these savings could provide if left invested.
Reduced retirement savings: This decision could have a significant impact on your future retirement income, leaving you with less financial security later in life.
Best Practices for Deciding What to Do
Deciding what to do with your 401(k) can be a big decision. Here are some best practices to keep in mind:
Understand your financial situation: Are you in genuine need of short-term liquidity, or can you afford to leave the money invested for your future retirement needs?
Consider investment options and fees: Compare the investment choices and administrative fees between your old plan, your new plan, and an IRA.
Weigh the tax consequences: Speak with a tax professional if you’re considering rolling your 401(k) into a Roth IRA to understand how much you might owe in taxes.
Work with a financial advisor: A fiduciary financial advisor can help guide you through this process so that your decision aligns with your overall financial plan. At Parkshore Wealth Management, for example, we help our clients make this decision based on their individual needs and goals.
The Bottom Line
When you leave a job, what to do with your old 401(k) is one of the most important financial decisions you’ll face. Each option has its pros and cons, so it’s essential to carefully evaluate them in light of your financial goals. Whether you leave it in your old plan, roll it over to your new plan or an IRA, or even cash it out, making an informed decision will help you stay on track for retirement success.
This decision doesn’t have to be made alone. A fiduciary financial advisor can help weigh the pros and cons of each option and guide you toward the best path for your unique situation.
Schedule a complimentary, 15-minute chat with a fee-only, fiduciary financial advisor today to discuss your personal situation.
This material was written in collaboration with artificial intelligence (ChatGPT) derived from sources believed to be accurate. This information should not be construed as investment, tax, or legal advice.
Parkshore Wealth Management is a family-owned, independent, fee-only Registered Investment Advisor with offices in Granite Bay and Folsom, CA, and Lehi and Logan, UT. We partner with financially responsible individuals and families who are eager to take positive steps that will allow them to use their money to build the life they desire. The firm is led by Harold Anderson, CFP®, and Daniel Andersen, CFP®, both members of NAPFA, the country’s leading professional association of fee-only financial advisors.