What Should You Do With an Old 401(k)?

An “old 401(k)” refers to a retirement savings account established with a previous employer. Individuals often have an old 401(k) after changing jobs, as their previous employer’s plan remains in place. Navigating these accounts can present questions about their management and how they fit into an overall financial strategy. Understanding the options for these accounts is an important aspect of personal financial planning.

Leaving Your Old 401(k) Account

One option for individuals with a 401(k) from a former employer is to leave the funds within the existing plan. Many employer-sponsored plans permit former employees to retain their account, especially if the balance exceeds a certain threshold, often around $5,000. If the balance is below this amount, the plan administrator might automatically roll over the funds into an IRA or even issue a check, subject to applicable tax withholding.

Leaving funds in the old 401(k) provides continuity of investments. The plan may also offer familiar fund options and institutional share classes not readily available to individual investors. However, accessibility to account information might be less convenient, as regular statements or communications may cease. Additionally, fees associated with the old plan could be higher than those found in an IRA, or they might not be as transparent.

Transferring Your Old 401(k)

Transferring an old 401(k) involves moving accumulated funds to another qualified retirement account. This process requires careful consideration of the destination and transfer method to avoid adverse tax consequences. The primary objective is to maintain the tax-deferred status of the retirement savings.

Preparatory Information and Decisions

Common destinations for a 401(k) transfer include a new employer’s 401(k) plan, a Traditional Individual Retirement Arrangement (IRA), or a Roth IRA. Moving funds to a new employer’s 401(k) is an option if the new plan accepts rollovers, allowing consolidation of retirement assets. A Traditional IRA is a frequent choice for rollovers, continuing tax-deferred growth. Converting a pre-tax 401(k) to a Roth IRA is another possibility, but this constitutes a taxable event in the year of conversion.

Two primary methods exist for transferring funds: a direct rollover and an indirect rollover. A direct rollover, also known as a trustee-to-trustee transfer, involves funds being sent directly from the old 401(k) plan administrator to the new account custodian. This method is preferred as it avoids immediate tax implications or withholding. In contrast, an indirect rollover involves the plan administrator issuing a check payable to the participant, who then has 60 days to deposit the funds into another qualified retirement account. Failure to deposit funds within this 60-day window can result in the entire amount being treated as a taxable distribution and subject to early withdrawal penalties.

When an indirect rollover occurs, the 401(k) plan is required to withhold 20% of the distribution for federal income tax purposes. To complete the rollover and avoid taxation, the individual must deposit 100% of the original distribution into the new account, covering the 20% withholding from other personal funds. The withheld amount is then credited back as a tax payment when filing the annual income tax return. Before initiating any transfer, gather account numbers for both the old 401(k) and the destination account, along with contact details for both plan administrators or custodians. Knowing the current balance and investment details of the old 401(k) is also beneficial.

Individuals should compare the investment options available in each potential destination, including diversity and quality of funds. Fees associated with the new account, such as administrative fees, investment management fees, or trading costs, are important considerations. Future access to funds and the individual’s personal tax situation, especially concerning a Roth conversion, should also play a role.

Initiating the Transfer Process

Once the destination and transfer method are chosen, initiate a direct rollover. The first step involves contacting the administrator of the old 401(k) plan to request a direct rollover. This contact can be made through the plan’s customer service line or online portal. The plan administrator will provide the necessary forms to process the transfer.

When completing rollover request forms, accurately provide the new account details. This includes the name of the new IRA custodian or employer’s 401(k) plan administrator, account number, and any specific routing instructions. Accurate information ensures funds transfer correctly and without delay. After submitting forms, follow up with both the old plan administrator and the new account custodian to ensure correct processing.

The timeline for direct rollovers ranges from a few days to several weeks, depending on complexity and responsiveness. Once initiated, monitor accounts to confirm funds have successfully moved. Verify by checking the new account balance to confirm the correct amount and allocation.

Withdrawing Funds from Your Old 401(k)

Withdrawing funds directly from an old 401(k) is an option, but it carries significant financial implications. Unlike a rollover, a direct withdrawal means taking money out of the retirement system entirely, making it immediately accessible for personal use. This action is discouraged due to associated costs and long-term impact on retirement savings.

Any amount withdrawn from a pre-tax 401(k) is subject to ordinary income tax. These funds are added to an individual’s gross income and taxed at their marginal income tax rate. In addition to income tax, withdrawals made before age 59½ are subject to an additional 10% early withdrawal penalty. This penalty is imposed by the IRS under Internal Revenue Code Section 72(t).

There are certain exceptions to the 10% early withdrawal penalty, such as withdrawals due to permanent and total disability, or those used for substantially equal periodic payments (known as 72(t) distributions). These exceptions are specific and require strict adherence to IRS guidelines. Cashing out an old 401(k) also results in the immediate loss of all future tax-deferred growth on those funds.

To request a withdrawal, individuals need to contact the old 401(k) plan administrator. They will provide the necessary forms, which require information like the reason for distribution and direct deposit or check details. The plan administrator will then process the request, withhold applicable taxes, and disburse the remaining funds.