Do you have an old 401(k)? Or possibly four?
The best time to make a decision about an old 401(k) is shortly after leaving the company. The next best time is—say it with me!—now.
What can you do with your old 401(k)?
- Keep it there, i.e., do nothing.
- Roll it into an IRA.
- Roll it in your new job’s 401(k).
- Roll the pre-tax part into your IRA and the after-tax part of it into your 401(k).
- If you have company stock inside it, roll that to a taxable account.
Once you get to a certain age (> 59 ½ years old) and stage of life (retired), the plan is to start taking money out of your 401(k) to spend, not just to move it into a different retirement account. So, that’s technically another option. But for people still in their earning years or younger than 59 ½, this is generally a bad idea.
How do you decide what to do with your old 401(k)?
Choose Between a 401(k) and an IRA
The first step is to figure out if you want your money in an IRA or 401(k). If you want it in a 401(k), then you can decide whether to leave your money in its old 401(k) or roll it into your current 401(k).
Although similar in many of the obvious ways, 401(k)s and IRAs operate by different rules, which can affect you meaningfully. Your specific life circumstances can make either an IRA or 401(k) a more appropriate place to hold your money.
Advantages of 401(k)s over IRAs
Advantages of IRAs over 401(k)s
You can often take loans from your current 401(k) (not from old 401(k)s or IRAs).
401(k)s have higher protection from creditors than do IRAs.
If you have any pre-tax money in an IRA, you cannot get the full tax benefits of a backdoor Roth IRA contribution (which requires a $0 pre-tax balance).
You can withdraw money from your 401(k) if you leave the associated job after turning 55, without penalty. You usually have to wait until age 59 ½ for IRAs.
The fee you pay your financial advisor might increase if your IRA balance—but not your 401(k) balance—goes up.
You won’t be required to take Required Minimum Distributions from your current 401(k) starting at age 73 as long as you’re still working. You will, from an IRA. (I know, I know, this is a Very Long Time From Now.)
You usually have a broader selection of investment options in an IRA. (This can sometimes be a “con,” what with analysis paralysis and some very inappropriate investment options available to you.)
You can withdraw money from a Roth IRA more easily (tax- and penalty-free) than from a Roth 401(k).
You can take penalty-free withdrawals to buy your first home, or to pay for qualified education expenses. Rules are different for a 401(k).
You can get more value from your financial advisor: Here at Flow, we can manage money in an IRA more easily as an integrated part of your total managed portfolio, which can open up some tax-optimization tactics (ex., asset location). We can also help with account administration (ex., setting beneficiaries, taking required minimum distributions, Roth conversions, etc.).
Your Choices for Your Old 401(k)
For each choice, I discuss pros and cons. When I’m evaluating each choice, I’m thinking about simplicity, fees, investment options, features, protections, and ease.
Keep it there, i.e., do nothing.
The pros? You don’t have to do anything! Also, possibly it’s a really great plan (low expenses, broadly diversified investment choices, good customer service and website interface). A lot of big tech companies’ 401(k)s are like this.
Also, 401(k)s can provide benefits that IRAs don’t, like higher protection against lawsuits.
Cons? If it was a “meh” kind of plan, leaving it there keeps your money in a “meh” place. And you’ll want to check with your former employer’s HR to see if you’ll be restricted in any way now that you’re a former employee. Does your access to the website or customer service change? Are you charged more fees now that you’re no longer an employee?
Also, you now have to keep track of one. more. account. One more account you have to manage investments in, manage paperwork for, set beneficiaries for, etc. This might not seem like that big of a deal when you have only one old 401(k) or when there’s not much going on in the rest of your life. But as life goes on and you start collecting a trail of 401(k)s from all former employers and you’re got career and family and health and friend demands on your time and energy…simplifying your financial life is gonna get real important, real quick.
Lastly, you might not be allowed to leave it there. Maybe your old employer gets acquired or goes out of business or changes the 401(k) providers. If the balance is too low (< $1000), they can just cash it out and send you a check. With balances under $5000, they might forcibly roll it into an IRA. Not ideal!
My “favorite” story about a client who didn’t roll a 401(k) over when he left his job: He didn’t just leave it there for a little bit, he left it there for over 10 years, during which time the company went through some changes, and the 401(k) plan provider changed…twice? I think. He had a vague notion that he had money in this 401(k) but didn’t have many details. We eventually tracked it down…to the state’s unclaimed property division! It is proving challenging to extract it.
Roll it into an IRA.
You can roll your 401(k) into an IRA at Schwab or Vanguard or Fidelity, or a “roboadvisor” like Betterment or Ellevest.
Pros? You can do this every time you leave a company and their 401(k), so instead of having a trail of 401(k)s, you have one 401(k) (your current one) and then one IRA (into which you have rolled all your old 401(k)s).
In an IRA at a regular ol’ “custodian” like Schwab, Vanguard, or Fidelity, you have access to the “universe” of investment options. Pretty much any stock or fund you can think of. Now, this “pro” can actually easily turn into a “con” or “information overload” or “analysis paralysis” or “what the hell am I supposed to invest in?” That’s where roboadvisors (or target-date funds) can come in really handy: they more or less do all the investing choices for you.
As a financial planner who manages her clients’ investments, I find it valuable (on behalf of my clients) to have more money in IRAs because that gives me more opportunity to use an “asset location” strategy to maximize after-tax returns over their investing lifetime.
Cons? If you roll your money into a pre-tax IRA (i.e., not Roth), you have made it impossible to do a backdoor Roth IRA contribution.
If you are working with a financial advisor, putting more money into your IRA might increase your fees. (This happens in my firm. Not immediately, and not always. But it’s generally in that direction.) Now, in my opinion, if you’re getting value in return for your fees, this isn’t a problem, but I think it’s important to be aware of how much you’re paying so that you can make that assessment.
Lastly, rolling 401(k)s into any other kind of account anywhere is often an exercise in bureaucratic pain. Sorry. It just is. Financial institutions apparently hate to lose your money and so often make it really hard for you to move your money away.
Roll it in your new job’s 401(k).
The biggest pro here? Again, simplicity. Having only one 401(k) at any given time. I can’t emphasize enough how valuable it is to “fight for simplicity” in your finances.
Also, if you end up leaving your job after you turn 55, you can start withdrawing without penalty from that job’s 401(k), not, and this is the point, from old 401(k)s. (Penalty-free withdrawals from 401(k)s usually start at 59 ½. You have to work a lot harder to get such access to your money in an IRA before that age.)
If you stay in your job, you won’t be required to take Required Minimum Distributions from the 401(k) at that job. (Now, this isn’t relevant until you are 73 years old. So, uh, we’re talking long-term planning if you’re our typical client.)
Lastly, though I don’t like seeing people take loans from their 401(k) (that money is for retirement, woman!), it is actually a possibility. By contrast, money in an IRA or an old 401(k) can’t be borrowed.
The cons? The bureaucratic pain of moving your 401(k) anywhere, as mentioned above. Also, maybe your new 401(k) isn’t that great. Maybe it’s expensive or has a crappy user interface that makes it hard for you to access or understand how your account is invested or get tax paperwork or or or.
(If you’ve just been laid off, you likely don’t have a new 401(k) yet. So, you might keep the 401(k) where it is for now, with the plan to roll it into your future job’s 401(k).)
Roll the pre-tax money into your new job’s 401(k) and the after-tax money into your Roth IRA.
This is starting to be the “icing” of personal finance, instead of the essential “cake,” but it is kind of a cool thing to do, so let me mention it.
Let’s say that you don’t want to roll money into your pre-tax IRA because you want to maintain your ability to do a backdoor Roth IRA contribution.
You might still want to roll your Roth money into a Roth IRA. (Yes, you can send your pre-tax money one place and your Roth/after-tax money another place.)
Why?
The rules that govern when you can withdraw what money from Roth accounts without penalty or tax are very complex. Oftentimes the rules are the same no matter which kind of Roth account you own, IRA or 401(k). But Roth IRAs do give you some access to tax- and penalty-free withdrawals that 401(k)s don’t, especially before you turn 59 ½ (the magic year after which you can withdraw from retirement accounts penalty-free).
It’s more complicated than that, so in general I think it’s just helpful to remember that Roth IRAs are slightly better than the 401(k) equivalent for getting money out of them.
Roll Your Company Stock into a Taxable Account and the rest of your 401(k) into another Retirement Account.
This strategy is called “Net Unrealized Appreciation.” It is pretty rare, is only relevant when you own company stock in your pre-tax 401(k), and usually only makes sense if that stock has grown a lot in value.
It involves rolling that stock into a taxable account, paying ordinary income taxes on the original purchase price of that stock, and rolling the rest of your 401(k) into an IRA all normal-like (which isn’t a taxable event).
This can get complicated, so I mention it here only to put a bug in your ear just in case you end up with a 401(k) chock full o’ highly appreciated company stock.
I was tempted to write something like “Don’t sweat the details too much” because I hate how stressed out everyone gets about what should be little items like moving a single old 401(k) to a new home. But good lord if I haven’t seen enough horror stories of old 401(k)s gone wrong to know that attention to detail will actually save you a bunch of hassle in the future.
And on that note, good luck!
Do you want help dealing with your old 401(k) (and all future old 401(k)s) from someone who will take a holistic look at your life and finances? Reach out and schedule a free consultation or send us an email.
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Disclaimer: This article is provided for educational, general information, and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. We encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Flow Financial Planning, LLC, and all rights are reserved. Read the full Disclaimer.