Starting a new job comes with plenty of changes, adjustments, and excitement. Throughout all the chaos, you might not think about what happens to your 401(k) when you change jobs.
However, neglecting your 401(k) retirement account can have costly consequences. It’s important proactively handle your old 401(k), so these savings continue to grow and benefit your retirement savings. Here’s what you need to get started.
What happens to your 401(k) when you change jobs?
If you don’t take action, such as initiating a 401(k) rollover, it will continue to exist where it is.
“The first mistake made by workers when switching jobs [is] neglecting to manage or pay attention to your old account,” says Greg Palacorolla, a certified financial planner and director of wealth management at Geier Asset Management in Maryland.
An unattended 401(k) could incur fees, penalties, or losses.
Brokers can cash out or roll over old 401(k)s
Your 401(k) won’t always stay where you leave it if the balance is less than $5,000.
Depending on the balance, your former company’s broker might be able to take certain actions on your 401(k), says Timothy Yee, president of Green Retirement, Inc. For example:
- If the balance is less than $1,000, the 401(k) broker can cash it out and send you a check for the balance.
- For a balance between $1,000 and $5,000, the company might force a 401(k) rollover into an IRA.
If you leave your 401(k) alone and the brokers take these actions, you will still face 401(k) cash out penalties. Or your 401(k) might be rolled into an IRA that’s not advantageous.
For instance, my husband had a Roth 401(k) with about $3,000 in it. When he went to a new company, he failed to roll it over. So the broker of his old Roth 401(k) rolled it into a traditional IRA – forcing my husband to pay taxes at withdrawal on money he’d already paid taxes for.
Your 401(k)’s fate is tied to your former employer
Your 401(k) might also get moved or transferred if your previous employer makes significant changes. If your previous company shuts down, is acquired, or switches retirement brokers, this could trigger a move in your 401(k).
“Since you are no longer an employee, you are often last in line to learn about any plan changes,” says Colin B. Exelby, founder of Celestial Wealth Management. “In addition, many people forget about old 401(k)s and how they are allocated. It is the old ‘out of sight, out of mind.’”
Student Loan Hero COO Max Spiegel ran into this issue recently with his 401(k) at a former employer. The company was acquired, and employee 401(k)s transferred to a different brokerage firm.
Spiegel didn’t realize this had happened. So when he logged into his account, it seemed as if his 401(k) had disappeared.
“I couldn’t find where my 401(k) was – scary stuff,” Spiegel says. After some legwork, he tracked down the new firm that held his account. However, it caused undue hassle and stress.
What to do with your old 401(k)
It’s important to know what happens to your 401(k) when you change jobs – and what your options are. You’ll want to have a plan for your 401(k) money. If you know how you want to use 401(k) funds, you’ll be able to choose the option that aligns with your goals.
There are four main options you have to continue managing your 401(k). Each option has its pros and cons.
1. Leave your 401(k) where it is
As mentioned above, your first option is to simply leave your 401(k) where it is. You don’t need to take any action to do so.
However, just because it’s the easiest option doesn’t mean it’s the best. And it doesn’t make it a handsfree retirement savings option.
“Regular management of the account is crucial to ensure that the best fund options are selected, the appropriate asset allocation is in place, and the ever-changing market and economy are taken into consideration when making decisions,” Palacorolla says.
Pros of leaving your 401(k) alone
- You keep your current 401(k). If you’re happy with your existing broker, funds, and allocations, you might want to leave it where it is. It also requires no initial action on your part.
- You preserve company stock. Maybe your 401(k) includes a high portion of your previous company’s stock you got at a discount. These and other special investments might be harder and costly to roll over.
- If you have company stock you bought at a discount in your 401(k), this could come with special tax considerations. You’ll want to consult a tax professional about your options before moving these kinds of funds.
Cons of leaving your 401(k) alone
- You have less control over your 401(k) and where it ends up.
- Your 401(k) could get cashed out or rolled over if it’s less than $5,000.
- You won’t be able to continue making contributions to this 401(k).
- Leaving it alone “may come with additional management costs where the employee is no longer employed at the company holding the 401(k),” says attorney Steven J.J. Weisman, a college professor at Bentley University.
2. Initiate a 401(k) rollover into a new 401(k)
If your new job comes with its own 401(k), you can roll your previous accounts into the new. “Transferring to the new company’s 401(k) is an easy and effective solution,” Weisman says.
To initiate a 401(k) rollover, you will need to contact your new plan’s administrator. They often have a step-by-step process you can complete to roll over your old 401(k).
Pros of rolling your old 401(k) into a new 401(k)
- You keep your retirement savings in one spot. This makes it easier to manage your investments, track your growth, and continue making contributions.
- Use your new 401(k)’s investment options or other features, like financial planning.
- Avoid tax penalties of cashing out the older 401(k).
- You might be able to retire earlier and start withdrawing savings at 55.
Cons of rolling over into a new 401(k)
- It might not be an option if your new employer’s 401(k) plans don’t accept transfers.
- Your new 401(k) might not have as many investment options as an IRA. “You are limited to investing in the funds available in your new company’s 401(k),” Exelby says.
- A 401(k) might have higher fees than an IRA.
3. Transfer 401(k) savings into an IRA
The process to roll over a 401(k) into an IRA is similar to a 401(k) rollover into another 401(k). To do this, you can open a new IRA (traditional or Roth – your choice). Then you can perform a trustee-to-trustee transfer of your 401(k) funds into the new IRA.
“IRAs provide access to the entire investment universe, which includes thousands of offerings,” explains Palacorolla. “Low-cost ETFs, individual stocks, and individual bonds are also available in IRAs, whereas 401(k) plans typically only offer mutual funds.”
It’s even common to open an IRA with the same broker that manages your 401(k) account. This makes the process of a 401(k) rollover into an IRA even easier.
Pros of a 401(k) rollover into an IRA
- “The biggest advantage to a rollover to an IRA is the significant increase in investment options,” Palacorolla says. That’s because a 401(k) usually has limited investment picks.
- IRAs tend to have more transparent fee structures and lower costs than 401(k)s.
- You can withdraw IRA funds and use them to buy a home or pay for college. There are no penalties for cashing out an IRA if you use the money toward a home purchase or qualified education expenses.
Cons of a 401(k) to IRA rollover
- Can’t make qualified retirement withdrawals from an IRA until you’re 59.5 years old.
- You want the option to borrow from retirement savings. A 401(k) allows for 401(k) loans, but you can’t borrow from an IRA.
4. Cash out your 401(k)
Lastly, you could always cash out your 401(k). To do this, you simply reach out to your 401(k) broker and request a cashout.
They will administer the process and send you a check for your balance – minus any penalties and fees incurred. And those fees will be significant.
“When you cash out your 401(k) plan you pay ordinary income taxes plus a 10 percent penalty,” says Nathan Garcia, certified financial planner and Managing Director of Westbourne Investments.
Pros of cashing out a 401(k)
- You get access to your money now and are free to use it however you want. And you might need it if you’re unemployed or facing a big purchase.
- If you’re 55 or over, you won’t face the 10 percent penalty on funds.
Cons of cashing out a 401(k)
- You’ll face the withdrawal taxes and a penalty fee of 10 percent, which could be a huge loss on your 401(k) funds.
- If you want to use your 401(k) to buy a home or pay educational costs, rolling over into an IRA and then cashing out will help you avoid penalties.
- By cashing out your 401(k) “you rob from your future by reducing your retirement funds,” Garcia says. Even if you replace your savings eventually, you can’t make up for the lost time that those savings would have been growing and compounding interest.
When you’re switching jobs, take some time to understand your 401(k) options and how each will affect your retirement savings. Then you can be proactive, choose what to do with your 401(k) after changing jobs, and set yourself and your savings up for success.
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