401k Options When You Change Jobs
When you start a new job, you likely have the option to contribute to a new 401k plan. This is a no-brainer, as you should almost always opt-in when you are eligible, especially to take advantage of any employer match offered. But what do you do with your 401k that’s with your old employer? Many people forget about their old accounts, about 24 million actually, with assets exceeding $1.35 trillion.
A survey in 2020 indicated that 40 percent of those leaving their jobs cashed out their 401k, including 62 percent of those with balances between $1k and $5k. Is this really a good idea? A $3k cash-out at age 24 can cost many, many times that amount by retirement. It makes sense to consider long-term consequences carefully. You have options for your old account, but what are they and which one is right for you?
Option 1: Leave your savings in your prior employer’s 401k plan.
Leaving your account with your prior employer is obviously easy. If you have less than $5,000 in your former employer’s account, you might be required to transfer the money out. If so, you’ll need to deposit the check into your new employer’s 401k or an IRA within 60 days to avoid paying taxes. Leaving amounts over $5k in an account with your old employer means you’ll have continued potential for tax-deferred growth and you won’t pay taxes until you start taking withdrawals.
On the other hand, since you’re not employed with that company any longer, you won’t be able to continue contributions. Also, 401ks are often limited when it comes to investment selections and sometimes can have high fees, which could take away from your ending balance. So, you’ll want to check the investment options and ensure they are right for you, as well as be ready and able to manage any reallocations or changes as needed.
Option 2: Transfer the money in your old 401k plan to your new employer’s 401k plan.
First, you’ll have to check to see if your new employer allows rolling money from a previous employer into the plan, as not all accept incoming rollovers. Consolidation is helpful to keep track and monitor your overall allocation and investments. Although, as mentioned, investments are often limited in 401k plans and there could be a more costly fee structure that you’ll want to consider.
When you roll your old account into your new account, your new employer controls the plan and can change the fees or investment options available as they wish. It may be necessary to sell out of the old investments into cash and reinvest in the new investments, depending on the plan and requirements. Also, you might wait six months to consider this option to make sure you see the employer as a long-term fit.
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Option 3: Rollover your old 401k into an IRA.
For the widest variety of investment options and the most control over your account, consider an IRA. There are benefits to consolidating your accounts in one retirement account, including ongoing management, diverse investment options and good asset allocation. The same 60-day deadline for properly rolling over the money from the 401k to this account applies here too.
One drawback to an IRA may be less asset protection than a 401k in case of bankruptcy, which varies by state. You’ll also need to ensure you follow rollover steps accurately, including separating any before-tax and after-tax contributions, to avoid any undesirable tax consequences. You also won’t need to worry about changing jobs in the future, as your IRA will allow future rollovers from 401k plans.
If you qualify and choose to convert your account into a Roth IRA, you’ll pay taxes on existing 401k funds at the time of the conversion, and then enjoy tax-free future earnings. IRA accounts have a 10 percent penalty on withdrawals before age 59.5 without an exemption.
Option 4: Cash out your old 401k account.
If you have no other option and are in need of fast cash, you might cash out your account. But you’ll owe taxes, and in many cases, a withdrawal penalty. This should be a last resort, as you’ll likely pay more in taxes than you would in retirement, and you’ll be losing out on years of tax-advantaged growth. Discussing this option with tax and financial advisors is a good idea.
It is your money and your choice. When you leave your job, just don’t forget about that 401k account, as you’ve worked hard to contribute. Also, make sure there are no outstanding loans that need to be paid back. Discuss your options with your financial advisor to make the most of your earnings and ensure you have a long-term plan to reach your retirement goals.
If you have a 401k that is with your previous employer and you would like to roll it over into an IRA, or if you have questions about your 401k options, schedule an appointment on Bayntree’s online calendar by selecting the date and time that is most convenient for you! You can also always reach us by emailing firstname.lastname@example.org.
Bayntree Wealth Advisors provides comprehensive financial planning and wealth management. The Bayntree team specializes in all aspects of financial health, including retirement planning, risk management, investment advice, tax strategies, estate planning and insurance.
Bayntree does not provide specific legal or tax advice. Please consult with your tax advisor or legal professional for guidance with your individual situation.