DR 111: What Should You Do With Your 401k When You Leave Your Job

What should you do with your 401k or 403b when you leave your job? This is a question that confronts more and more people. According to the Department of Labor young Baby Boomers held on average 11.3 jobs from age 18 to 46. So it was no surprise when I received the following email from a reader named Juan:

In this article, we’ll look first at your options. Then we’ll cover some factors to consider as you choose the best option for your circumstances. And finally, we’ll cover some of the mechanics of actually rolling over a 401k to another 401k or IRA. Note that this article applies equally to both 401k and 403b retirement accounts.

Listen to this Article:

Options for a 401k When You Leave a Job

The first thing is to understand are options. When you leave a job with a 401k or 403b you have potentially four options when it comes to your retirement plan:

Take the Money: While I include this as an option, it’s not one that will do your retirement planning any favors. Taking the money will trigger ordinary income tax. If you are not 59 1/2 or older (or otherwise able to take a qualified distribution), you may also get hit with a 10% additional tax. So while this is technically an option, I’m going to assume for the sake of this article that it’s not one you are considering.

Leave it Alone: Most 401k plans allow you to leave your money in the 401k at your old employer. You won’t be contributing to the account anymore, but you can continue to invest the money in the funds available in the plan. Note that this option may not be available for 401k accounts with balances of less than $1,000. For balances of less than $5,000, you may need to take steps to prevent your old employer from automatically distributing the funds to you.

Rollover to Current Employer’s 401k: If your new employer has a 401k or 403b and permits rollovers, you can rollover the money to the retirement plan at your new employer.

Rollover to an IRA: Finally, you can always rollover the 401k to an IRA.

Considerations in Making Your Choice

What should you consider in deciding which option is best for you? While there is no one right answer for everybody, there are some important factors to take into consideration. The very first factor is access to good investment options.

Investment Options

One of the big potential downsides of a 401k or 403b is that some of them have lousy investment options. For that reason, it’s important to consider the investing options at both your old employer and your new employer. Part of this evaluation should look at the expense ratios of the mutual funds in both plans. Also, keep in mind that you may not need every mutual fund choice in a plan to be a good option. As you build your asset allocation plan across multiple accounts, you may only need one or two good investment choices with your 401k.

If the investment options at the old employer are good and fit your asset allocation plan, leaving them there is a reasonable option. You don’t have to go through the hassle of moving the money. In fact, that’s exactly what I did with my first employer. I was there for 10 years. When I moved to another job, I left my money in the company’s retirement plan because I was happy with the investment choices.

Simplicity

The second thing to consider is simplicity. The fewer accounts you have, the easier it is to manage. That’s true when it comes to rebalancing a portfolio and keeping track of your investments. If you have good investment options at your new employer, rolling your account over from your old employer to your new employer minimizes the number of accounts you have. If you happen to have good investment choices at both your old and new employer, you’ll have to weigh the inconvenience of the rollover with the inconvenience of managing two accounts. In the long run, I favor the simplicity of consolidating accounts. Further, as we’ll cover in a moment, it’s not at all difficult to rollover a 401k.

Age 55 Rule

The third thing is the age 55 rule. This is one I think a lot of people tend to forget. If you leave your employer in or after the year you turn 55 you can begin to take withdrawals from your 401k without incurring the 10% penalty. What happens if you leave your employer at age 54? Can you wait a year until you turn 55 and then start taking money out without penalty? No. This exception only applies if you leave your employer in the year you turn 55 or later. Of course, you’ll have to pay ordinary income tax assuming it’s a traditional 401k or 403b.

So what does this have to do with a 401k rollover? The age 55 rule does not apply to IRAs. If you rollover a 401k to an IRA, you cannot take advantage of this rule. Therefore, you should consider this factor when deciding what’s best for your retirement account.

Rollover Tips

If you decide to rollover your 401k or 403b, you’ll want to use what’s called a direct rollover. A direct rollover is the movement of your investments from one plan directly to another plan. In other words, you don’t get access to the funds. A direct rollover is quick and convenient.

There is such a thing as an indirect rollover where you do touch the money. The money comes to you and you then have 60 days to roll it over into the IRA or 401k. There are several drawbacks to an indirect rollover. First, your old employer may withhold 20 percent of the rollover for taxes. While you’ll get that money back eventually, you’ve got to come up with that extra 20 percent now to roll over the whole amount into your new account. Further, if you fail to rollover the assets within 60 days, the IRS treats the assets as a distribution. The result can be a very big tax bill, including the 10% penalty.

Finally, the easiest way to begin the direct rollover process is to contact the new plan administrator where you want your money to go. They likely have an entire department dedicated to helping investors execute a 401k rollover. They will walk you through the paperwork and make sure everything is processed properly.

Where Should You Open an IRA?

If you’re going to open up an IRA, where do you open it? The key to answering this question is to decide first what types of investments you’ll purchase. For example, if you want to invest in funds at Fidelity, then it makes sense to open the IRA at Fidelity. That’s true if you want to invest in funds at any mutual fund company. If you have a certain fund company you prefer, open the IRA with the mutual fund company. Not only do you invest for free into their investment products, but you can always add a brokerage account to invest in stocks, bonds, or ETFs.

If you want to invest in a broad array of ETFs and stocks, then a low-cost brokerage makes the most sense. Brokers offer IRA accounts that enable you to rollover a 401k. TD Ameritrade is my personal favorite because trades are inexpensive and they have physical offices just about everywhere. I’ve also used OptionsXpress, which offers a $100 new account bonus. You may have a different broker you prefer, but if you’re going to trade a lot of ETFs and individual stocks, a low-cost brokerage is a good option for an IRA.

The fourth option, of course, is a robo-advisor. These tools take a lot of the work out of creating an asset allocation plan and rebalancing your portfolio in exchange for a fee.

Related: How to Build Your Own Benefits Plan If You Leave Your Job