Changing Jobs? Finance Tips on What to Do With a 401K Retirement Plan

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Changing Jobs? Finance Tips on What to Do With a 401K Retirement Plan

401K retirement plan

Congratulations on your new job! Before you are too far gone from your old position, you need to decide what to do with the 401(k) account balance at your old employer. Financial planning business owner Mike Mills warns that your decision could be the difference between losing and gaining large sums of money for your retirement.

Beware of Cashing Out Your 401(k)

"Many people take their 401(k) balance as cash because they do not know there are much better alternatives available," says Mills, a certified financial planner. "This is the worst option, and any other available option should be used when someone changes jobs." If you take your old 401(k) balance in cash -- in the form of a check -- the plan administrator will withhold income taxes from your account balance. If you do not roll the money into another qualified retirement plan, the money becomes taxable income, plus you must pay an extra 10 percent tax penalty if you're under age 59 1/2. When you change jobs, there is no rush to do something with your 401(k) money, so take your time to consider alternatives that will keep your money growing while deferring taxes until you retire.

Check Employer Plan Ratings

You're not required to do anything with an old 401(k) account and can choose to leave the money in your previous employer's plan. Another option is to transfer the account balance from the old plan to your new employer's 401(k) plan, if the new plan allows transfers; most plans do. Before going with one of these options, Mills recommends that you check the online Brightscope rating of both employer plans. "Look for a rating of 80 or higher from Brightscope on a 401(k) plan," he says. "A lower rating indicates plan expenses are high and you can get better investment return if you take control of the money."

Consider Rolling Over Your 401(k) Into an IRA

Another way to avoid tax consequences and maintain control of your money is to move the 401(k) from your old employer to an individual retirement account. This is known as a direct rollover. You can accomplish a direct rollover by opening a new IRA, obtaining a direct rollover request form from the 401(k) plan administrator and completing the form with the details of your IRA account. Mills says, "In most cases, it is best to take control over your 401(k) assets by transferring the money to an IRA. In the IRA the individual controls the investments and costs." In an economy where you may change jobs several times, the direct rollover options allows you to consolidate your retirement plan savings from different employers as your career progresses.

Look for Low-Cost Retirement Plans

Before rolling over your 401(k) funds, compare different IRAs, including any fees you would have to pay. "Costs are the biggest single predictor of future results. You give yourself the best chance for investment returns by selecting the lowest-cost products for your 401k rollover," Mills says. He suggests rolling over 401(k) money into an IRA without any annual fees and investing the money in low-cost index mutual funds. (Index funds base their investments on a market index like the Standard & Poor's 500.) There's no guarantee of which investments will give you the best return over a working career of 401(k) contributions. However, Mills says low expenses can result in tens if not hundreds of thousands of dollars more available for your retirement compared with average- and high-cost plans.