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Anytime you’re starting a new job or making a significant life change, there are some important things to consider. And one of those decisions may be what to do with your employer-sponsored 401(k).
If you recently quit your job, should you leave your 401(k) where it is? Or should you move the money into a new account? There are several options you can choose from, but you want to get this right.
Making the wrong move could end up costing you thousands of dollars in fees. Let’s look more at what a 401(k) rollover is and whether or not it’s the right decision for you.
What is a 401(k) Rollover?
A 401(k) rollover is when you transfer the money out of your current 401(k) into a new tax-advantaged retirement account. Many people do a 401(k) rollover when they quit their current job or are getting ready to retire.
There are several different ways you can do this. But most people either roll over the funds into their new employer’s 401(k) or an individual retirement account (IRA).
You do have the option to cash out the account altogether. But this is not usually advised because of the hefty penalties and taxes that come with it. Plus, if you close the account, you’ll miss out on years of tax-advantaged savings.
Pros
- Convenience: One of the biggest advantages of a 401(k) rollover is making the account easier to manage. That’s especially true if you have multiple accounts — it will be easier to monitor the progress once everything is consolidated into one retirement account.
- Possible employer match: Some employers are willing to match 401(k) contributions. If your employer offers this benefit, then you should take advantage of this free money. Doing so will help you increase your retirement contributions.
- Tax savings: If you request a direct rollover, you may be able to avoid paying taxes. Since the funds are going straight from one account to another, you’ll get to keep 100% of your retirement savings.
Cons
- Fewer investment options: One of the downsides of a 401(k) is that you have fewer investment options. You’ll mostly be able to invest in mutual funds, bonds, and index funds. So this may not be the best option for someone looking to diversify their investments.
- Less control: With an employer-sponsored plan, you’ll have less control over the money. That’s because the plan administrator will decide how the account is maintained.
- Potential for higher fees: If you move your funds to a new account, you may get stuck paying higher fees. Even a slight raise can cost you thousands of dollars in fees.
How to Start a 401(k) Rollover
Decide What Kind of Account You Want
Before you can rollover the funds, you need to decide what kind of account you want. If your new employer offers a 401(k), then this may be an easy decision. You can also roll over the funds into an IRA.
Opening an IRA is a good option for someone who wants more control over their account. With an IRA, you can pick your investments and will have more choices. You can also use a Robo-advisor that will select your investment options for you.
If your new employer offers a 401(k), you want to understand what they’re providing. For instance, will they match your contributions? If so, this benefit alone may be worth a 401(k) rollover.
Take some time to consider your options and determine what kind of account works best for you and your financial needs.
Open the New Account
Next, it’s time to open the account. If you’re transferring the funds to an employer-sponsored 401(k), the plan administrator should be able to walk you through this process.
If you’re opening an IRA, you’ll need to find a brokerage account that meets your news. Once the IRA is open, you can start the process of transferring the money into your new account.
Ask for a Direct Rollover
Regardless of which account you choose, it’s essential to request a direct rollover. In a direct rollover, the funds are transferred from one account to another.
With a direct rollover, you won’t have to pay any taxes or penalties for the transfer. If you receive any of the money, it’s considered a distribution, and you’ll have to pay fees and taxes.
If you do an indirect rollover, the plan administrator may withhold part of the funds to pay taxes. However, you can get that money back if you remember the 60-day rule. Deposit the entire balance into your new account within 60 days, and you’ll be refunded for the amount withheld.
Choose Your Investments
And finally, you need to choose your new investment options. If you roll over the money into your new employer’s 401(k) plan, the investment options may be limited.
If you open an IRA, you may have more options to choose from. For instance, you can choose between mutual funds, exchange-traded funds (ETFs), stocks, and bonds. If you need some guidance on selecting the best investment strategy, a financial advisor can help.
Should You Leave Your 401(k) Where It Is?
A 401(k) rollover is relatively easy to do, and if you do a direct rollover, you won’t have to pay any fees or taxes. But if you’re not ready to transfer the funds, can you leave your 401(k) where it is? My best answer is, maybe.
You’ll have to contact your former employer to figure out what your options are. They may be willing to let you leave the money where it is. But you want to make sure that your fees won’t go up as an ex-employee.
The Bottom Line
Most people choose to do a 401(k) rollover after quitting their job. You can transfer the funds into a new 401(k) or open an IRA. If you’re unsure of what to do, you might consider talking to a mentor or financial advisor for guidance.
I rolled over a seven figure 401K account when I retired five years ago. Oddly they said they could not transfer the money directly but would have to send me a check made out to my chosen IRA custodian, Vanguard. So I got a check for $1.4 Million in the mail and had to mail it to Vanguard. And my 401K was held by Wells Fargo, not some tiny company. It was pretty weird holding a check for that much of my own money! I hope they have a better system in place now.