Should I Roll Over My 401k to a New Employer?
Your old 401k doesn't have to be an afterthought. Understand the subtle differences in cost, control, and features to align your savings with your goals.
Changing jobs presents a financial decision regarding the 401(k) from your previous employer. The choice you make can influence the growth of your savings, the fees you pay, and your future access to the money. Navigating this decision requires understanding the available paths and evaluating how each one aligns with your personal financial situation and future goals.
Available Options for Your Old 401(k)
When you leave an employer, you have four choices for the money in your 401(k) account.
- Leave the funds within your former employer’s plan. This is an option if your balance is over $7,000, allowing your money to remain invested and grow tax-deferred. You will no longer be able to contribute to this account or take a loan from it. For balances between $1,000 and $7,000, the plan can automatically roll your funds into an IRA, and for balances under $1,000, the plan might cash out your account.
- Roll the funds into your new employer’s 401(k) plan. This choice allows you to consolidate your retirement savings into a single account, simplifying management. This is only possible if your new employer’s plan accepts rollovers, which you must confirm with the new plan administrator.
- Roll the funds over to an Individual Retirement Account (IRA). This moves your savings to a personal account that you control directly, often providing a much wider range of investment choices. Pre-tax 401(k) money can be rolled into a Traditional IRA, and Roth 401(k) money can be rolled into a Roth IRA, preserving the tax treatment.
- Cash out the account and receive a lump-sum distribution. This choice is highly inadvisable because the distribution is treated as taxable income. If you are under age 59½, you will also face a 10% early withdrawal penalty from the IRS on top of federal and state income taxes.
Key Factors for Making Your Decision
A primary factor in your decision is a comparison of fees and expenses, which erode your investment returns over time. These costs include administrative fees and investment-specific expense ratios, found in plan documents like the annual fee disclosure. Compare the fees in your old and new 401(k) plans against the fee structure of a potential IRA, where you might find lower-cost options.
The variety and quality of investment options are also a consideration. Some 401(k) plans offer a limited menu of mutual funds, while an IRA provides access to a broader universe of investments, including individual stocks, bonds, and low-cost funds. Review the investment lineup in your 401(k) plans to determine if they meet your diversification and performance expectations.
Plan rules and specific features create differences between your options. A 401(k) plan allows you to take out a loan against your balance, a feature not available with IRAs. Another provision is the “Rule of 55,” which allows penalty-free withdrawals from your 401(k) if you leave your job in or after the year you turn 55. This benefit is lost if you roll the funds into an IRA, where withdrawals before age 59½ would still be penalized.
Consider the level of creditor protection. Funds held in a 401(k) are broadly protected from creditors under federal law. The protection for IRAs is more complex. While funds rolled over from a 401(k) into an IRA retain strong federal protection in bankruptcy, protection for all IRAs outside of bankruptcy is determined by state law and can vary.
Rules for Required Minimum Distributions (RMDs) differ. If you are still working past age 73, you can delay RMDs from your current employer’s 401(k). This “still working” exception does not apply to IRAs or 401(k)s from previous employers, which require you to begin taking RMDs at the mandated age regardless of employment status.
Consolidating your funds into a single account, whether it’s your new employer’s 401(k) or an IRA, can simplify management. A single account makes it easier to track your portfolio’s performance and manage your asset allocation. Juggling multiple accounts from past jobs can become cumbersome and may lead to overlooking management tasks.
Executing a Rollover
In a direct rollover, the administrator of your old plan sends the money directly to the new 401(k) or IRA. This is the recommended method because you never take possession of the funds, which avoids tax consequences.
An indirect rollover is more complex. Your old plan administrator sends you a check, from which they are required to withhold 20% for federal income taxes. You then have 60 days to deposit the full amount of the original distribution, including the withheld 20%, into a new retirement account. If you fail to deposit the full amount in time, it is considered a taxable distribution.
To initiate a rollover, first decide on the destination for your funds, either by confirming your new employer’s plan accepts them or by opening an IRA. Next, contact the plan administrator for your old 401(k) to request their rollover distribution paperwork. Complete the forms, ensuring you select the direct rollover option, and provide the account information for the new destination account. After you submit the paperwork, follow up with both plan administrators to confirm the funds have been successfully transferred.