As many of you know, I resigned my job a couple weeks ago and since then I have started my new job. During my first week at my new job I enrolled in my benefits plans and now need to figure out what to do with my old 401(k). Basically, there are 5 options for my 401(k).
401(k) plan options when you transfer jobs:
- Leave the assets in the current 401(k) plan.
- Roll the assets into an IRA
- Roll the assets into new employer’s 401(k) plan.
- Withdraw the assets in a lump sum.
- Transfer the assets to a qualified annuity.
So let’s look at my options:
1. Leave 401(k) assets in current plan with former employer.
The easiest thing to do is leave your assets in your current employer’s plan. It takes no action on your part. However, if you have less than $5,000 in your account, your employer can close the account and return your money to you. If you have more than $5,000, you can usually keep your money in the account.
Possible Advantages: If you have a great selection of investment options, you can leave your assets in place and continue to invest as you have been. Leaving it in your old account also keeps your tax deferred investments in a qualified retirement account. You maintain the option of moving your funds at a later date.
Possible Disadvantages: Your investment options are limited to the options in your old plan. You will not be able to make new contributions, nor will you be able to take any loans from your old 401(k) account. Learn more about Roth IRA contribution limits here! You may be held liable to pay for account fees, as some companies will not cover those costs for former employees. You will also have one more investment account to maintain and balance. Keep in mind, 401(k) providers may change from time to time and it is up to you to keep track of these changes. Kiplinger has a good article about keeping track of old 401(k) plans.
Verdict: Consider this if your old plan has better investment options than your new plan. Otherwise, consider rolling your 401(k) into your new plan, or one of the other following options.
2. Roll the assets into an IRA
Your 401(k) assets are already in a tax advantaged account and rolling your 401(k) into an IRA will keep your investments growing with the same tax advantages and you will avoid the 10% early withdrawal penalty.
Possible Advantages: In addition to avoiding the 10% early withdrawal penalty and maintaining tax advantages, there are several other important benefits to rolling your 401(k) into an IRA. The biggest advantage is that you control your investment options and you are no longer limited to the investment options in your old or new 401(k) plan. This is important because you can limit your expenses and you maintain control over your accounts. Some companies change trustees and it is not your old company’s duty to notify you of any changes, it is up to you to keep track. Keep in mind that rolling your 401(k) assets into an IRA plan isn’t final – you may be able to roll it into your new 401(k) plan later. You also maintain flexibility for beneficiaries.
Possible Disadvantages: You will not be able to take loans from your IRA as you would be able to if you rolled it into your new employer’s plan. There are also several disadvantages regarding withdrawals from an IRA vs. a 401(k); in certain circumstances, 401(k) plans have a little more flexibility.
Verdict: Consider this option if you want total control over your investment, your old plan doesn’t have enough assets to keep it open, your new plan does not offer strong investment options, or you want to consolidate your investment holdings into fewer accounts.
3. Roll the assets into new employer’s 401(k) plan
This is an option I am strongly considering, but it will depend on several factors – notably my new 401(k) plan’s investment options. The other factor that I like is simplifying the number of investment accounts I need to keep track of, maintain, and balance.
Possible Advantages: Your investment maintains its tax advantages and there are no penalties to transfer or rollover your money. You will be able to borrow against your 401(k) holdings if you wish to do so, and you will minimize the number of retirement accounts you have.
Possible Disadvantages: You are limited to your new plan’s investment options. This is a biggie if your plan has limited options or higher than average expense ratios, which eat away at your returns. There may also be a waiting period before you can sign up for your new company’s 401(k) plan, which means you would have to wait to roll it over.
Verdict: Consider this option if your new plan has strong investment options and/or you want to maintain simplicity in your retirement holdings.
4. Withdraw the assets in a lump sum
Withdrawing your assets from your 401(k) plan is not something most people will recommend because you will be hit with taxes and early withdrawal penalties, which could eat up nearly a third of your total assets to that point.
Possible Advantages: Your assets (minus income taxes and early withdrawal penalties) will be available for immediate use.
Disadvantages: You will face the immediate tax impact of paying income taxes on the lump sum of the assets you withdraw (usually an immediate 20%), and you will also have to pay a 10% early withdrawal penalty if you are under age 59½. You will also lose tax deferral benefits on your funds, miss out on potential future earnings, and you will lock in any market losses that had occurred up to that point. Most importantly, you can severely reduce the amount of money you have for retirement.
You can change your mind within 60 days. Your old fund manager is required to deduct 20% for taxes when you withdraw your funds. If you change your mind and decide to roll the funds over, there is the 60-day rollover rule which allows you to roll the money into an IRA within 60 days. However, you will be required to come up with the 20% difference to reinvest the entire amount and avoid paying income taxes. You will get the 20% back when you file taxes the following year as long as you complete the rollover within 60 days.
Verdict: Consider this option only if you need the funds immediately and you cannot meet those expenses through other means. But I strongly advise you to speak with a financial planner to look at other options before doing this.
5. Transfer the assets to a qualified annuity
Transferring your 401(k) to a qualified deferred annuity is not an option many people know about, and one which fewer people take. Except in certain instances, it is not the best option.
Possible Advantages: Assets continue to be tax deferred until you receive distributions and you will not pay taxes or early withdrawal penalties to transfer your 401(k) directly to a qualified annuity. An annuity creates an income stream that you won’t outlive, instead of having a finite pool of money from which to withdraw funds (if you live a long time, you could outlive the amount of money you paid into the annuity). Your heirs may be able to inherit your annuity if you pass away during the accumulation phase.
Possible Disadvantages: Rolling a 401(k) into an annuity is an irrevocable decision; once made, the decision cannot be reversed. Many annuities come with higher expense ratios than 401(k) plans or IRAs, and some states charge high tax premiums on annuity purchases. In addition, you may pass away before your annuity pays out the amount of money you would have had in your 401(k) or IRA, leaving nothing for your heirs.
Verdict: This is not for me. This is not to say annuities are bad, but there are many variables involved and I do not know enough about them to write about all their intricacies. If you think this may be for you, consider speaking with a certified financial planner or other professional for more details. Final note: beware of salesmen. Many annuities are pushed heavily because they are extremely profitable for the company that manages them.
Best options for your old 401(k)
In most cases, the best option will be to transfer your 401(k) assets to an IRA or your new 401(k) plan, or simply leave your 401(k) assets in the old plan. Your decision should be based on your particular situation.
What will I do with my 401(k)?
Actually, I haven’t decided yet. My goal for this month is to investigate my new 401(k) plan and compare it to my old company’s 401(k) plan and determine the best option for me. Personally, I think I will either roll it into my new company’s plan, or I will roll it over into an IRA. I prefer to limit the total number of accounts I have because it makes it easier to balance my portfolio and keep track of everything.