When you change jobs, you can take one of 4 actions with your 401k: roll out to an IRA, roll to a new 401k, leave behind, or cash out. There is no one-size-fits-all answer, but about half of job-changers leave their accounts behind, probably because it’s the default (no-effort) choice. Let’s look at each option so you can make an informed decision about what to do with those old 401k accounts.
Roll out to an IRA – This is usually the best choice. Because IRAs are portable and owned personally, there are no employer strings attached. Here are some benefits to rolling to an IRA:
- Complete control You can invest wherever and in whatever you want (subject to IRS regulations).
- Roth conversion You can gradually convert to a Roth IRA as your tax bracket and available savings allow. To learn more, see my post How to Convert to a Tax-Free Roth IRA
- Lower cost Under Department of Labor regulations passed in 2012, 401k accounts are supposed to make plan costs “transparent” to participants. Three years later, the majority of participants still have no idea what they are paying and whether it is a good deal. (Note: BrightScope’s rating tool is a simple way to evaluate your plan.)
- Early withdrawal penalty exceptions IRAs offer exceptions to the 10% early withdrawal penalty for such reasons as first-time homebuyer ($10k) and qualified higher education (unlimited) for you, your spouse, children, or grandchildren. You can also structure penalty-free payments from your IRA under the “72t SEPP rule”. This is a method of annuitizing your IRA to take out Substantially Equal Periodic Payments.
Roll over to another 401k – To be able to do this, you must qualify to participate in a 401k at your new job and the plan must allow rollovers into the plan. Consider a 401k to 401k rollover in the following circumstances:
- If you plan to retire between ages 55 and 59 ½ If you separate from service at age 55, you can take money from your 401k penalty-free.
- If you need to borrow from your 401k IRAs do not allow plan loans, but 401k’s do.
- If you plan to continue working beyond age 70 ½ If you own less than 5% of your employer’s business, you can defer taking RMDs (Required Minimum Distributions) as long as you are working, even if you are over age 70 ½.
- If you are contributing to a “Backdoor Roth IRA” Contributing to a Backdoor Roth IRA is a great way to sock away tax-free retirement money (see my video on Backdoor Roths). But this maneuver will not work for you if you have a pre-tax IRA in your name already. By rolling out to an IRA, you will no longer be able to utilize a backdoor Roth – or you’ll pay extra taxes if you do.
- If you are concerned about a lawsuit or bankruptcy Much has been made about the superior protection that a 401k affords over an IRA. But, unless you have over $1M in your IRA, most states provide the same wall of security.
Leave it behind – The only time I recommend leaving your 401k behind is if your current employer doesn’t offer a 401k and you are contributing to a backdoor Roth IRA. That doesn’t mean you should forget about it, though. You will still receive statements and you can continue to rebalance annually and adjust as your goals change.
Cash it out – This is not a choice I would recommend normally, but it is probably the second-most popular move. Here are a couple of times I might endorse cashing out:
- If you have high-interest credit card debt and less than $10k in your 401k
- If you are over age 59 ½ and won’t pay a penalty
- If you are in the 10% or 15% tax bracket
Leaving multiple 401k’s behind to languish can make a bigger dent in your retirement than you realize. If I’ve convinced you to do something about your orphan 401k and you need to know the next steps, just refer to my prior article on What to do with an old 401k, part 1. Did you know gender makes a difference in saving? Find out if men or women are less likely to save enough for retirement and what you can do about it.