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401(k) when you change jobs

You just changed jobs. You’re excited about the new company, new opportunities ahead, etc. Did you decide what to do with your old 401(k)? Do you know what your choice are? You can withdraw the money and pay ordinary income tax along with penalties (bad choice). You can leave it in the old 401(k) and forget about it (it may be okay to leave it there, but for Pete’s sake, don’t forget about it).

Twisting the Knife
Creative Commons License photo credit: Roger Smith

Today, I’d like to talk about the two better choices, rolling into the new 401(k) account, or rolling into an IRA.

Why would you want to put the money into the new 401(k)? A few good reasons come to mind. The expenses are so low, you can’t do better on your own. (disclosure – the expenses on my company’s S&P fund is .05%, less than Vanguard or the SPY ETF. I pay less over 20 years than some people pay for a managed fund in under a year.) On the flip side, high expenses may steer you toward just depositing enough to grab the match, if any, and invest in an IRA or taxable accounts.

A 401(k) may have a loan provision – this is a tricky one. It’s easy to make a huge mistake by taking a loan, losing your job, and having it treated as a early withdrawal. If used wisely, it can also be a cheap source for a loan, they usually run at prime or slightly over. You can’t borrow from your IRA, at best you can grab the money for 60 days while you move it between account, but this is playing with fire.

Age 55 retirement – If you separate from your company at age 55 or older, you can take 401(k) withdrawals with no penalty, just the taxes due. In theory, you can do the same with your IRA via what’s known as Section 72(t) withdrawal, but it’s a bit more cumbersome.

Last, say you have some IRA money already, some post tax (the rest pre-tax, deducted from income in the year deposited.  If you intend to convert any of these IRA funds to a Roth, the amount is taxed in the same ratio as the ratio of pre-tax and post-tax funds in there. The 401(k) rollover into your IRA might swing that balance against you. As far as the IRS is concerned, you have one IRA (An Individual Retirement Arrangement) regardless of the number of accounts it resides in.

Now for the benefits of the IRA choice. As mentioned above, the fees may be high on the 401(k) and you view the rollover as a way of getting out from under these fees. If the 401(k) represents most of your retirement money, and you would like the ability to convert some funds to a Roth for whatever reason, this is your chance to do it through the the IRA. It’s not an all or none prospect, you can first convert the full amount to an IRA, and convert over the years, a small amount at a time.

An IRA also offers much greater flexibility of investment choices. You may invest in mutual funds, ETFs, individual stocks, etc. You can also break the funds up into multiple accounts, with different brokers or the same, and set up different beneficiaries as you wish. The beneficiary can stretch the withdrawals over their lifetime to maximize the IRA benefit. 401(k) withdrawals are at the mercy of the administrator’s plan documents, not all are so flexible.

Given how often people tend to change jobs nowadays, it makes little sense to leave a trail of 401(k) money behind you. As Thoreau said, “Simplify, simplify, simplify.” Good advice, I’d agree.

Joe

  • Katy Song July 10, 2010, 5:35 pm

    I wish everyone knew the information listed above. Most of my clients have chosen to “forget” about old 401(k)s, which puts them behind schedule towards their retirement goals.

  • Tim Rosen July 10, 2010, 6:00 pm

    I agree whole-heartedly that rolling over the old 401(K) to a self-directed IRA is wise and financially prudent choice. Most participants in 401(k) have ZERO guidance or advice as to how to “slice” their pie, and when the going gets rough, they tend to sell at the bottom and “try” another fund choice in the plan, resulting in unnecessary losses and under-performance.

    A rollover would mean freedom on many levels. Thank you for posting this very important topic!

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