If you’ve recently left an employer, you might be wondering if you can merge your old 401(k) with your new one. The good news is that in most cases this is possible, but you’ll want to think about the various consequences of rolling over your account well in advance of taking any action. Here, we’ll look at the pros and cons of combining your 401(k) plans.
Pros and cons of rolling over your 401(k) to a new employer
Benefits of rolling over your 401(k) to a new employer
- Consolidation. Whenever you have an opportunity to consolidate your accounts without any unnecessary tax consequences, it’s a good idea to look into doing so. Assuming you had a pre-tax 401(k) at your previous employer, and you have one now with your new employer, it can be smart to combine the two. Having fewer accounts tends to be easier to manage — both administratively and psychologically — so it’s usually worthwhile to pare down when you can.
- More control. When you have your 401(k) investments in one place, it’s far easier to coordinate your investments, and you’re immune from magically forgetting one of your old accounts. This tends to lead to a feeling of greater control, which, in nearly every aspect of life, is a positive thing.
- Possibly lower fees. This is really only knowable on a case-by-case basis, but it’s entirely possible that your new employer has a 401(k) plan that’s simply cheaper than your old one. If so, you’ll benefit in the long run by combining the accounts.
- Possibly better investments. Similar to the comment on fees, your new plan might have better investments than your old one. This can mean a wider investment menu, or it can mean lower-cost investments, but in either case you’d be better served moving the money to the superior plan.
Drawbacks of rolling over your 401(k) to a new employer
- Requires some work. You’ll need to investigate the benefits of your new plan relative to your old one — and take the time to set up a direct rollover between plan providers. It may sound like a difficult process, but it really doesn’t need to be. Some people balk at the extra work and simply leave their old 401(k) plan as is, but there are really some nice benefits to consolidation.
- Possibly higher fees/worse investments. While the opposite case was considered above, it’s conceivable that your new 401(k) plan will actually be inferior to your old one. Perhaps it has outdated investments or is laden with unnecessary and redundant management fees; whatever the issue, you’d probably be better off leaving your old 401(k) where it is if moving it will make it harder to grow your money.
Pros and cons of rolling over your 401(k) to an IRA
For simplicity, let’s assume you have a pre-tax 401(k) at your former employer, and you also have a pre-tax 401(k) at your new employer. Aside from the minimal work you’ll do to arrange the transfer, there really aren’t too many things that can go wrong. You’ll wait for the money to arrive in your new employer’s plan, and then invest the money according to your broader asset allocation.
When you move your 401(k) to an IRA (a traditional IRA in particular), however, there will be some meaningful changes that happen:
Benefits of rolling over your 401(k) to an IRA
You can invest in what you want.
IRAs give you access to the entire investment universe via flexible brokerage accounts. At most discount brokerages across the internet, you’ll be able to open an account and trade at no cost.
Your account is independent from any employer.
Many people seem to like the additional freedom you have with an IRA in that it’s separate from any employment arrangement and under your sole control.
Drawbacks of rolling over your 401(k) to an IRA
You’ll lose access to the Rule of 55.
401(k)s are unique in that if you decide to retire at age 55, you’ll be able to take distributions from the account penalty-free. Theoretically, you can use your 401(k) as a penalty-free way to bridge the gap in income from age 55 to 59.5. With an IRA, this option doesn’t exist.
You’ll lose priority creditor protection.
Are there tax implications for 401(k) to 401(k) rollovers?
If you’re working with a pre-tax (or “tax-deferred”) 401(k), and you merge it with a new 401(k) of the same tax status, there won’t be any tax consequences. When you combine accounts, no income is declared; you’re only, in effect, changing the custodian for the money.
Tax issues begin to creep in when you start mixing pre-tax accounts with designated Roth accounts, or “after-tax” accounts. Any amounts transferred from pre-tax 401(k)s to Roth accounts (401(k)s or IRAs) will be fully taxable at your ordinary income rate, better known as your highest tax rate. So before you make any transfers from tax-deferred 401(k)s to Roth accounts, be absolutely sure you understand how this plays out 一 and what it will cost you 一 when it comes time to file your tax return.
What are some other 401(k) rollover exceptions and considerations?
Some of the unusual 401(k) exceptions include:
If you change jobs while you still have a 401(k) loan outstanding, you’ll only be able to roll over the net balance, which is your total balance less any outstanding loans. You’ll also be responsible to repay the outstanding loan from your previous provider within 60 days; if you fail to do this, the entire amount of the loan will be considered taxable income and also subject to a 10% premature distribution penalty.
Direct vs. indirect rollovers.
Generally speaking, the best way to complete any sort of rollover is by utilizing a direct rollover. You’ll need to call your previous 401(k) provider, and they’ll coordinate with your new employer to directly transfer your balance between the two institutions.
An indirect rollover occurs when you, as an individual, withdraw your old 401(k) balance and then assume responsibility for depositing it into your new 401(k) within 60 days. If you don’t re-deposit the money within that time frame, you’ll be liable for ordinary income tax and a 10% early distribution penalty if you’re below 59.5. Indirect rollovers are worth avoiding, especially if you have the capability to do a direct rollover.
You can roll over a 401(k) into a Solo 401(k).
If you’ve decided to go out on your own after several years working in formal employment, you should know that you can merge an old 401(k) with a newly-created Solo 401(k). Solo 401(k)s have higher contribution limits than do traditional 401(k)s, so they’re worth investigating if you’re now self-employed.
- There are various pros and cons to consider before moving your 401(k) anywhere. The important thing is that you give it some thought!
- You can safely transfer your 401(k) to your new employer with minimal hassle and no tax consequences, provided you read all the fine print.
- Rolling money to a 401(k) is different from rolling money to an IRA. There are pros and cons to either decision.
- 401(k) rollovers can come with unusual exceptions, especially if you have any outstanding loans on the plan or if you want to attempt an indirect rollover.