4 Things to Do with Your 401(k) When You Change Jobs
When you change jobs, you face an important financial decision. What should you do with your 401(k) account? You have four choices. We explore the pros and cons of each choice below to help you make an informed decision.
1. Keep your money in your former employer's 401(k) plan
This is your legal right if you have at least $5,000 in your account. Ask how long you have to decide. In most cases, you get 30 to 90 days. If your account holds under $5,000, your employer has the option of cashing you out of the plan. (If that's your situation, skip to choice #3.)
- You’re familiar with the plan. And you may think it’s an exceptionally good one.
- It’s easy; you don’t have to do anything.
- Once you’re no longer an employee, your access to your money may be limited. You may only be allowed a set number of investment choice changes—or even prohibited from taking distributions until you reach retirement age. Ask what the rules are.
- As a former employee, you may be charged extra maintenance fees. A company that subsidizes its 401(k) plan's record-keeping expenses for active workers may be less generous with participants who no longer work there.
2. Roll your money into your new employer's 401(k) plan
Almost all 401(k) plans now accept rollovers from other retirement plans. You should certainly contribute to your new plan. But should you transfer your old account into it?
- Consolidating your retirement money makes it easier to manage. When you've left a retirement account at a company you no longer work for, you may pay less attention to its performance or downplay its importance in your overall asset allocation.
- The new plan may offer more attractive investment options than the old one, as well as additional services, such as financial-planning advice.
- The new plan may offer fewer investment options or investments that don’t meet your needs.
3. Move your money into an Individual Retirement Account (IRA)
This choice gives you maximum control and flexibility. With a 401(k) plan, the employer chooses the investments and makes the rules—and the rules vary from plan to plan. With an IRA, you’re in charge.
- Unlimited investment choices instead of a small menu. Every 401(k) plan has limited investment options; by contrast, you have total freedom of choice in an IRA, which can be invested in as many mutual funds, stocks and bonds as you want.
- Greater control over your investment expenses. 401(k) plan fees are rarely disclosed, and in many cases they're higher than what you'd pay for comparable investments outside the plan. Picking low-cost funds for your IRA can save you tens of thousands of dollars over time.
- Greater freedom to name beneficiaries. The beneficiary of your 401(k) plan, by law, must be your spouse; you have to obtain a signed release from him or her if you want to name anyone else. With an IRA, you can name any beneficiary you wish.
- Taxes will be withheld unless you move the money from your 401(k) to an IRA via a trustee-to-trustee transfer. To avoid this issue, first set up a new IRA then ask your old employer to transfer your money directly from the 401(k) plan into the new account.
4. Cash out your old account
Think long and hard before you do this. It’s almost never the best choice—and it triggers a big tax bill!
- It’s money you can use to pay bills or for another purpose. Also, if you left your job during or after the calendar year in which you turned 55, you won’t owe an early-withdrawal penalty.
- You’ll owe income taxes on your money. If you're in a 30% combined federal and state tax bracket, for example, and cash out a $50,000 account, you'll have only $35,000 left after taxes. (And the distribution might even push you into a higher tax bracket in the year you take it!)
- You will destroy your retirement nest egg.
The bottom line: For most people, the best option is to move your savings into an IRA, which gives you the most freedom and control over your money.