What Should I Do With My Old 401(k)?

An “old 401(k)” refers to a retirement savings plan sponsored by a former employer. Individuals often accumulate these accounts when they change jobs or retire, leaving behind funds in a plan they no longer contribute to. Deciding what to do with these funds impacts long-term savings and retirement security. This article explores the various options available for managing an old 401(k).

Leaving Your 401k with Your Former Employer

Leaving funds within your former employer’s plan is one option. This passive approach requires current contact information. Your retirement savings will remain invested according to the plan’s available options, continuing to grow on a tax-deferred basis.

Most plans allow former employees to keep funds if the balance exceeds a threshold (e.g., $5,000 or $7,000). If your balance is below a specific amount (e.g., $1,000), your former employer might automatically cash out or roll it into an IRA. You will no longer be able to make new contributions.

Funds remain subject to the plan’s investment menu, administrative fees, and rules. This is suitable if satisfied with the plan’s performance, low fees, and features. However, it may lead to a fragmented retirement portfolio if you accumulate multiple old 401(k)s from different employers.

Transferring to a New Employer’s 401k

You can move your old 401(k) funds into your new employer’s qualified retirement plan (e.g., 401(k), 403(b), or 457(b)). This direct rollover moves funds directly from the old plan administrator to the new. This consolidates your retirement savings, simplifying management.

Direct rollovers are tax-free. Confirm your new employer’s plan accepts external rollovers. Evaluate the new plan’s investment options and fee structure to align with your financial goals.

To initiate, contact both plan administrators. Request a direct rollover form from your former plan with new plan details. Funds are typically made payable directly to the new plan administrator, preventing taxable distributions and maintaining tax-deferred status.

Rolling Over to an Individual Retirement Account (IRA)

Rolling over your old 401(k) into an IRA offers flexibility and control over your investments. You can choose to roll funds into either a Traditional IRA or a Roth IRA. A direct rollover to a Traditional IRA is tax-free, preserving its tax-deferred nature.

Converting funds from a traditional 401(k) to a Roth IRA is a taxable event. The entire amount converted becomes taxable income. This can be beneficial for a higher tax bracket in retirement or for tax-free income. After-tax 401(k) contributions can typically be rolled into a Roth IRA without additional tax, while the pre-tax portion is taxed upon conversion.

Open an IRA account. Instruct your old 401(k) administrator to directly roll over funds. If you receive a check, it must be made out to the IRA custodian and deposited within 60 days to avoid taxes and penalties. Missing this deadline or not depositing the full amount (including 20% mandatory withholding) makes the distribution taxable and may incur an early withdrawal penalty.

Withdrawing Funds Directly

Directly withdrawing funds from an old 401(k) means taking a lump-sum distribution. This has immediate and significant tax consequences. The entire taxable portion of the distribution is subject to ordinary income tax rates.

For individuals under age 59½, a 10% early withdrawal penalty generally applies. Exceptions to this penalty include distributions made due to:
Disability
Certain unreimbursed medical expenses exceeding a percentage of adjusted gross income
Separation from service in or after the year you turn age 55 (Rule of 55)
Qualified birth or adoption expenses (up to $5,000 per child)
Certain payments made after the account owner’s death

When you request a direct distribution, the plan administrator is typically required to withhold 20% of the taxable amount for federal income taxes. This withholding may not cover your full tax liability, and you may owe more when filing your tax return. Due to income taxes and potential penalties, directly withdrawing funds significantly reduces your retirement savings.

Choosing the Right Path for Your Situation

Choosing the right path for your old 401(k) involves evaluating several personal financial factors. Consider fees and expenses, as these vary significantly between old 401(k) plans, new employer plans, and IRAs. Some older plans may have higher administrative costs or limited, more expensive investment choices compared to modern options.

Investment options are important. IRAs typically offer a wider array of investment vehicles (e.g., stocks, bonds, mutual funds, ETFs) not always available in a 401(k). Emergency access also differs; while direct withdrawal incurs penalties, some plans or IRAs may offer loan provisions or hardship withdrawals.

Creditor protection varies; 401(k) plans generally offer strong federal protection, while IRA protection depends on state laws. Required Minimum Distribution (RMD) rules also differ: Roth IRAs do not require RMDs during the original owner’s lifetime, unlike traditional 401(k)s and IRAs, which typically begin at age 73. Consider future contributions and alignment with your overall financial goals and long-term retirement strategy.