Most people will work for several companies throughout their career. As you move to another company, you should be careful not to forget about your retirement investments. Unless your old employer’s plan had solid and low cost investment options, you should seriously consider rolling your investments over to an IRA.
Aside from increasing your investment options, rolling your 401(k) protects you from early withdrawal penalties associated with cashing in your account. The key is finding a way to manage your retirement fund effectively and stick with your overall retirement plan.
Why cashing out is a bad move
When moving from one job to another, you might be tempted to cash in your retirement account to pay off some bill, or even have a little bit of fun. Don’t do it. If you do, you’ll get hit hard. Twice.
For starters, you’ll expose that money to income taxes, and it might even be enough to bump you into a higher tax bracket. On top of the taxes, you’ll also get hit with a 10% early withdrawal penalty.
I learned this the hard way when I changed jobs years ago. Since I didn’t meet the minimum balance requirement to keep my old 401(k) open, I was sent a check with the balance of my account.
I should have immediately opened an IRA and completed a rollover, but instead I used it to pay off bills. I thought I was being smart, but the penalties ate a good chunk up of my savings, and I was left with no retirement savings.
I won’t ever do that again. Next time, I’ll inform HR to send it to my IRA directly, avoiding the temptation for me to spend the cash.
Where to roll over your 401(k)
You have two options for rolling over your retirement fund, either to an IRA or into your current company’s 401(k). You’ll have to the weigh the pros and cons for yourself.
Into an IRA
You’ll have complete control over your money with an IRA. You can choose your preferred brokerage or mutual fund company, and you’ll likely wind up with more and better investment options than with a 401(k).
If you’re working with a financial planner (fee only, please!), feel free to ask for their advice on the matter. I would also suggest you check out some of the following companies to see if they would fit your needs:
In most cases, you can initiate the rollover online. Just be sure to have all of your old 401(k) information on hand. When we opened an account with Vanguard, we were able to fill out all of the information online, but we still had to sign and mail the documents.
As with any financial transaction, just be sure to read all of the paperwork carefully, and don’t be afraid to call and ask questions if anything is unclear.
New company’s 401(k)
The primary advantage of this option is simplification. By rolling your investments into your new 401(k), you’ll have one fewer account to deal with. Another advantage, if you want to call it that, is that you can borrow from your 401(k), but not an IRA.
In my view, the ability to borrow isn’t typically an advantage, though there are some circumstances in which it might be the best option available. By having all of your funds in a 401(k), you’ll have a larger balance to borrow against.
Another consideration, of course, is whether or not your new plan accepts incoming rollovers. Even if they do, you might have to satisfy a minimum waiting period before you’re eligible.
Choosing your investments
If you’re looking for the easiest option that you can set and forget, you might want to look into target date mutual funds. These funds are designed to adjust asset allocation as you get closer to the retirement date, though there are some disadvantages to them.
Index mutual funds are another great option for people who are willing to construct their own portfolio while minimizing their expenses. Index funds are designed to track specific market indices, and thus don’t incur expenses associated with an active fund manager.
Exchange traded funds (ETFs) are similar to index funds in that they typically track a market index. ETFs can be traded through out the day like stocks. One major downside of ETFs is that, depending on where you buy and sell them, you may have to pay brokerage fees.
If you’re looking for some more information to help you decide, there are plenty of posts on the topic here at FiveCentNickel:
- Index Mutual Funds vs. Exchange Traded Funds (ETFs)
- ETFs vs. Index Mutual Funds, Revisited
- Avoiding and Reducing Mutual Fund Fees and Expenses
- Stocks and Bonds vs. Mutual Funds
And here are some articles on asset allocation:
- Our Investment Portfolio: Asset Allocation and Location
- Reconsidering Our Asset Allocation
- The High Cost of Low Risk Investing
- How Much International Exposure Should Your Portfolio Have?
- Market Turmoil, Portfolio Drift, and Asset Allocation: Time to Rebalance?
I would also recommend reading a few good books on investing if you’re going to start taking a more active role in managing your portfolio.
Your Thoughts on Rolling Over Your 401(k)
Have you changed jobs in the past? If so, how have you handled your associated retirement savings? Did you leave it in place? Roll it into an IRA? Or maybe you rolled it into your new 401(k)? Do you have any tips for making the process easier?
When I left my last job I rolled over my 401(k) within a few months. I did a direct rollover when I opened the new IRA account. I like having as few accounts as possible and did not want to have to keep track of and manage another with a different brokerage, not to mention more options and less expensive fees.
Re progressive tax brackets, this is relevant when considering a rollover to a Roth IRA, or traditional to Roth conversion. An underused tactic is partial rollovers where you limit your marginal tax rate by rolling over just the amount of assets that keep you within your tax bracket. This can be especially useful when your out of work or starting a new business and have no/low income for a year.
Rollovers are almost always a good option if you are comfortable picking your own investments. Unless your new job is with a large company, it’s likely you can find the same fund options available in a 401k plan through a retail broker at much lower cost. Small company 401k plans can charge as much as 2% a year to your account. The median expense ratio is 0.78% for plans with $10 million and $100 million in assets; and 0.41% for those greater than $500 million (Deloitte Consulting and the Investment Company Institute). The cost advantage of low cost mutual funds or ETFs in a online broker’s or fund co’s free IRA can make a big difference compounded to retirement.
A higher tax bracket is a bad thing in this context b/c the tax bite on those marginal dollars might wind up being een greater than expected. We’ve already written extensively about the progressive nature of our tax system.
Why do mention being bumped into a higher tax bracket like it’s a bad thing? You might want to make it clear to your readers that we’re on a progressive tax system and detail what that means. It’s not like if I make one more dollar, all of my income goes from being taxed at 15% to being taxed at 28%.
Having just received a statement from an old 401K (two or three jobs ago) that’s doing surprisingly well right where it is — and leaving it there is just fine with my former employers — I’m probably not going to roll it at all. I guess back when I worked there, I had more investing savvy than I seem to these days. Wish my current 401K looked as good…
Rollover. Every 401(k) that I’ve had experience with so far has had too many fees.
My strong preference would be for a direct rollover. I’m not really concerned about cashing the check and spending it, but handling the rollover myself is just one more hoop to jump through, and also one more way something can get mixed up. I’d rather let the custodians sort it out themselves.