Where Should I Put This 401(k)?

How to Choose the Best Place to Move Your 401(k) or Retirement Plan

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A friend recently left a job she had for many years. She was taking some time off and considering a small business start-up. I asked, as I always do when I hear someone is changing jobs, what she was going to do with her 401(k) plan?

"I guess it’s just staying at my old job," she said.

"So your former company is going to continue to manage it?" I asked.

"I don't know," she replied. "I just assumed it would. Last time I left a job I had to cash out because I didn't have a lot in there. But I have much more saved now, so I figured I could just leave it there."

I am glad I asked, because when it comes to your retirement plan, you don’t want to make assumptions. If you are not sure what is happening with your employer-sponsored, defined contribution retirement plan when you leave a company, you need to find out. Unless your former employer doesn’t mind continuing managing your funds, you need to make a decision within 60 days or the funds in the plan will automatically be distributed to you or another individual retirement account. Whether you are leaving a job due to a company move, layoff, firing, or lifestyle change, the company should be very clear about what you need to do with your retirement plan.

It is up to you what to do next.

Retirement Plan Options When Changing Jobs

When you leave a job, you could do a number of things:

  • You could leave the money with your former employer. Some employers will allow this if you have a balance exceeding $5000. Others will force you to move the money from the plan within 60 days or they will move it for you. If the former employer does allow you to keep your money in the account, you still have to deal with at some point. Leave a plan behind at every job and by the end of your career you could wind up with a 401(k) graveyard filled with neglected investments that put your overall portfolio out of whack. Unless the investment options in the old 401(k) are so uniquely amazing they are impossible to find elsewhere, you need a long-term plan for moving those funds. There are some reasons to consider leaving your retirement plan with a previous employer including familiarity with investment options, potentially lower fees, separation of service rules, professional guidance, and protection against lawsuits.
  • You could move the money directly into your new employer's retirement plan. Many employers will offer the option of a plan-to-plan rollover into their 401(k) or other qualified retirement plan. Just as you move your skills and experience to the new job, you move your retirement nest as well. There are no tax consequences or penalties with this move, and your employer should offer instructions to walk you through it. This can be a very easy option that keeps your savings momentum, as long as you like the investment choices in the new plan. It's also nice to start a new 401(k) with a nice, healthy balance. And if your employer offers loans, you have a larger pool of funds available to you (although 401k loans are not necessarily recommended).
  • You could move the money into a Rollover IRA and choose your own investments. A Rollover IRA is an account you open that’s a place for your old 401(k)s and retirement plans. If you tend to move from job to job as you climb the career ladder, a Rollover IRA is a great option. When you do a direct rollover, there are no tax consequences or tax penalties involved. And Rollover IRAs offer endless investment options to choose from—including stocks, bonds, mutual funds, ETFs, even real estate—if that's what you are looking for. On the downside, you will no longer be making regular contributions to this account, so that account will lose a bit of momentum. However, Rollover IRAs are so flexible, you may be able to roll the assets back into a future employer’s plan.
  • You could take the 401(k) money and run. This is called a lump-sum distribution, and it’s obviously the worst option. For one reason, you will automatically take a tax cut of 20% and if you are younger than 59 ½, you will likely pay an additional 10% penalty. Considering your tax bracket and potential state and local taxes, you could lose half of your savings. If that’s not bad enough, you lose the savings momentum you had in the retirement plan, and the time spent growing the money.

What If You Don’t Do Any of These Things?

According to the Internal Revenue Service, if your savings balance is less than $5000, your employer does not need your consent before distributing the funds from the plan. However, if there is more than $1000 in your plan and you don’t opt for another type of distribution, your plan administrator is required to move the funds into an IRA. This is a fairly new rule, and helps investors stay committed to their retirement savings plan.

If your 401(k) balance is less than $1000, you could accidentally take a lump-sum distribution without realizing it. You may think $1000 is no big deal. But with the magic of compounding, $1000 can grow quickly if you continue to build upon it with continued contributions of between 6% and 10% of your pre-tax salary.

If you do get an accidental lump-sum distribution but are still within 60 days of terminating your old plan, you can still roll the money over into a new employer's plan or Rollover IRA. You should be able to claim any taxes or penalties paid on your tax return. (It makes sense to discuss this with a tax profesional beforehand.) Once the 60 days have passed, the IRS says the only exemptions that will be considered are in cases where the financial institution moved the money improperly.

Many Accounts, One Portfolio

If you keep your investments working in different accounts, give yourself an overall picture of how your investments are working together. You want to keep your portfolio balanced while avoiding a lot of investment overlap or excessive expenses.

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