Figuring out what to do with your 401(k) when changing jobs can feel intimidating. We’ve spelled out your 4 key options in this guide below.
If you’ve ever wondered what to do with a 401(k) when you’ve changed jobs, you’re not alone. Millions of Americans change jobs each year and face a similar question. Unfortunately the information we receive from our employers at the time of job-change can be confusing. The result is that many of us decide to deal with the situation later, especially given everything else we might have to do alongside a job-change. While that’s understandable, the money in our 401(k) accounts is a huge asset and making a well-informed decision on what to do with it doesn’t have to be time-consuming. There are 4 main options, each with different pros and cons.
If you’re under 59 1/2 then a 401(k) withdrawal is almost never a good idea, unless you have an emergency and really need the cash. Why? Because you pay taxes on the money you withdraw plus a 10% penalty. You also give up the opportunity for your 401(k) savings to grow tax-free over decades. This is known as “leakage” and it’s a big reason why people don’t end up saving enough for retirement. There are some limited circumstances in which you can withdraw from your 401(k) without taxes and penalties — some of these are known as hardship withdrawals — but avoid cashing out your 401(k) if you can.
This is known as a 401(k)-to-IRA rollover, or a 401(k)-rollover for short. According to data released by the IRS, almost 5 million Americans roll over their 401(k) into an IRA each year and they transfer over $500 billion in total. Rollovers are tax-free transfers of money from one retirement account to another. Moving assets from an old 401(k) into IRA is a popular choice because it allows you to keep track of your retirement savings — your money ends up in an account that’s tied directly to you, not your former employer. It also allows you to pick an IRA provider that offers the investment options and fees you want – rather than being beholden to the 401(k) provider chosen by your legacy employer. There’s a typical 5-step process involved in rolling over an old 401(k) to a new IRA.
When you change jobs and roll over your 401(k) into an IRA, the rollover does not count as a contribution. This makes choosing a 401(k) rollover a good way to build savings in an IRA as you can still contribute to your IRA up to 2022’s limits.
Many people choose to open a Roth IRA because investments and savings grow tax-free in a Roth IRA. While anyone can open a Roth IRA, its generally best to roll over a Roth 401(k) into a Roth IRA. If you contributed to a Roth 401(k) before changing jobs, then you can roll over into a Roth IRA.If you choose to roll a 401(k) into a Roth IRA, then the funds count toward your contribution limits. Depending on your income, that could potentially send you over your contribution limits, leading to penalties. While some may still benefit from this type of rollover, most people prefer to roll their 401(k) into a traditional IRA.
Like a Roth 401(k), a Roth IRA consists of funds that have already been taxed, so retirement savings can grow tax-free. However, to roll over into a Roth IRA you must already have a Roth 401(k). If your previous employer offered a Roth 401(k) and you’re looking to roll over into a Roth IRA, the first step is to open a Roth IRA at your preferred provider. After you change jobs, contact your old employer to roll the Roth 401(k) into the new Roth IRA.
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If your new employer also offers a 401(k), then this is a possibility. It’s known as a 401(k)-to-401(k) rollover. It’s generally trickier than rolling over into an IRA and can take longer to do, according to estimates provided by the GAO. It’s also not always possible because the new company you’re going to might not offer a 401(k) or have restrictions on rolling over 401(k) accounts from previous employers. But if your new employer and plan allow a 401(k)-to-401(k) rollover then it’s worth considering, especially if you like the investment options and fees in your new 401(k). There are 5 key differences between 401(k)s and IRAs that are useful to review before you decide which type of rollover to pursue.
Many Americans leave their 401(k)s behind when they change jobs, at least temporarily. The key advantage of this is that their 401(k) savings remain invested in a tax-deferred account, and there’s no effort involved.
Ultimately, though, most people don’t like the idea of having their money tied to their old employer for too long. It’s much easier to lose track of what fees are being charged and what our money is invested in if it’s in an old 401(k) account that we rarely check. There’s also a risk that your old employer initiates what’s known as a forced rollover to an IRA provider of their choice. This usually happens for small accounts under a certain size (usually less than $5,000). Your old employer might also choose to switch 401(k) providers, which means your money gets moved to a new institution with different fees and investment options — without your input.
Don’t forget about your 401(k) when changing jobs
In the chaos of a job change, it can be easy to forget about our 401(k). While leaving your money in your old employer’s 401(k) plan is an option, it should be weighed against rolling over those assets into an IRA or another 401(k). Withdrawing, or “cashing out” your 401(k) should be avoided unless absolutely necessary. Spending a little time to decide what’s right for your 401(k) savings when changing jobs can help keep you on track for retirement.