What to Do With Multiple 401(k) Accounts?

As individuals navigate their careers, accumulating multiple 401(k) accounts from different employers is common. Understanding the various options for managing these retirement savings is important for informed financial decisions. Each approach to handling old 401(k) accounts carries distinct implications regarding access, investment choices, and potential costs.

Keeping Old 401(k) Accounts

One option is to leave funds within a previous employer’s 401(k) plan. This choice may be suitable if you are satisfied with the plan’s investment options and fee structure. Some older plans might offer unique investment choices or lower administrative fees than newer alternatives.

However, retaining old accounts requires ongoing monitoring. Forgotten accounts can arise, leading to a lack of oversight regarding investment performance and changes in plan rules. Investment choices within an employer-sponsored plan are often more limited compared to IRAs. Administrative challenges, such as updating contact information, can also become burdensome.

Transferring to a New Employer’s 401(k)

Consolidating previous 401(k) accounts into a new employer’s plan streamlines retirement savings. This process involves a rollover, moving funds from one qualified retirement plan to another. A direct rollover is recommended, as funds transfer directly between administrators, avoiding immediate tax implications or withholding.

An indirect rollover involves funds distributed to you first; you then have 60 days to redeposit them into a new retirement account to avoid taxes and penalties. For indirect rollovers from employer plans, a mandatory 20% of the distribution is withheld for federal taxes, requiring you to use other funds to complete the full rollover.

Evaluating the new employer’s plan is important, considering factors like the variety and quality of investment options. Fees, including administrative and investment management costs, can vary significantly, ranging from 0.5% to 2% annually. Assess the availability and terms of 401(k) loans if desired. 401(k) plans generally receive strong federal creditor protection under the Employee Retirement Income Security Act (ERISA), safeguarding assets from creditors.

Rolling Over to an Individual Retirement Account

Rolling over funds from a 401(k) into an Individual Retirement Account (IRA) provides increased control and flexibility over retirement investments. This rollover can be directed to either a Traditional IRA or a Roth IRA, each with distinct tax treatments.

A Traditional IRA receives pre-tax contributions and offers tax-deferred growth, with withdrawals typically taxed as ordinary income in retirement. Conversely, a Roth IRA is funded with after-tax contributions, allowing for tax-free growth and tax-free withdrawals in retirement, provided certain conditions are met.

A crucial consideration when moving pre-tax 401(k) money to a Roth IRA is that the conversion is a taxable event. The entire converted amount is generally subject to ordinary income tax in the year of conversion. This tax liability must be weighed against the benefit of future tax-free withdrawals.

Moving funds to an IRA grants access to a broader range of investment choices compared to employer-sponsored plans, which can lead to more diversified portfolios. While some IRAs may have annual maintenance fees, often ranging from $25 to $50, many providers offer accounts with no such charges. Transaction fees for trading securities can also apply.

Consolidating multiple retirement assets into a single IRA can simplify financial management and potentially lower overall fees. This consolidation can also streamline estate planning, making it easier for beneficiaries to manage inherited assets.

However, IRAs generally offer less federal creditor protection than 401(k)s, primarily limited to bankruptcy cases up to a certain amount. Additionally, IRAs do not typically offer loan provisions, unlike some 401(k) plans. The process involves contacting the former 401(k) administrator and the chosen IRA custodian to initiate a direct rollover, ensuring funds move seamlessly.

Withdrawing Funds from an Old 401(k)

Directly withdrawing or “cashing out” funds from an old 401(k) account is generally not advisable due to significant financial penalties and tax consequences. Any amount withdrawn is typically subject to ordinary income tax. Beyond that, if the withdrawal occurs before age 59½, an additional 10% early withdrawal penalty is usually applied by the IRS.

Exceptions to this 10% penalty include withdrawals made after separating from service in the year age 55 is attained, or distributions made as part of a series of substantially equal periodic payments (SEPP) under IRS Rule 72. Other exceptions may apply for total and permanent disability, unreimbursed medical expenses exceeding a certain percentage of adjusted gross income, or in cases of qualified domestic relations orders.

Even if the penalty is waived, withdrawn funds remain subject to regular income tax. Cashing out also means losing the benefit of tax-deferred growth and compounding returns over many years, which can significantly diminish long-term retirement savings. While extreme financial hardship might compel such a withdrawal, it should be considered a last resort given the substantial financial implications.