Each day, I am inundated with questions from my readers. If you want to send in a question send it to admin@yourfinancessimplified.com. Here is one that I received recently that I want to share with you.
The Reader’s Question
What is, if any, the benefit of keeping a 401k account with a previous employer or should it be either rolled over or placed into a separate investment account (ie. IRA)?
My Response
Keep in mind there are 4 things you can with the 401k money from an old employer.
- Roll over the funds into an individual retirement account
- Leave your 401(k) behind
- Transfer the money to your new employer’s plan
- Take the money and run
The last option is the worst case scenario b/c of penalties. I wouldn’t do that one at all unless it’s really necessary.
Leaving Money In
People generally leave the money in their old 401k if they like the performance they are getting. You can do this if you have good solid investments that you’re happy with, and it’s not a problem to leave the money there. However there are some exceptions.
- If your account holds less than $1,000, your employer is allowed to automatically cash out your account when you leave.
- If your account holds between $1,000 and $5,000, most employers will automatically roll your 401(k) into an IRA when you leave your job.
- If your account holds more than $5,000, you must decide whether to leave your money behind or take it with you.
Leaving it in the old 401k also might alleviate some fees. Emphasis on the might! Mutual funds affiliated with 401(k) plans typically waive load fees for plan participants and transaction costs for 401(k) investors can be lower. Meanwhile, IRAs frequently charge an annual (though nominal) maintenance fee. However, if your 401k charges high fees, you might be better just rolling it over.
Rolling it Over
The benefits of rolling over to your own IRA or new 401k (if you got a new job) is control and possible lower fees.
Both traditional and Roth IRAs offer a wide variety of funds, individual stocks, bonds and certificates of deposit from which you can choose. That you can essentially invest in almost anything is a major benefit with IRAs, with 401(k)s you’re limited to investments that your employer provides and, in some cases, they may not be good.
If you opt to roll your fund into a traditional IRA, you will pay no upfront taxes, although you will pay tax on their withdrawals during retirement. If you roll over into a Roth IRA, you will pay their taxes upfront, but the earnings will grow tax-free.
The answer depends on how much you like your old 401k vs. the control you get from rolling it over.
What will you do?
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Dominique Brown
Dominique Brown is the CEO of DNB Financial Planning, landlord, financial educator and non-profit owner. He enjoys working out, helping others and everything finance. His sole purpose for creating this website is to share his passion of personal finance and to help you simplify your finances. I love questions.. So feel free to ask me anything!
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Out of the 4 choices, #4 is the worst unless youre in serious financial strengths. IRAs are certainly the best way to go, but most people think of these as only stock market kinds of investments. What many people don’t realize is that they can diversify their portfolio in their IRAs by doing what s called a “self directed” IRA in which you can use the funds to invest in other vehicles such as real estate. No penalties as long as its handled properly. sure, invest in the stock market but beware of keeping all your eggs in one basket. Real estate is on the upswing right now and investors are looking for private money to fund their deals. Just an option to consider.
Excellent post. I deal with this issue on a regular basis with clients and generally we will move old 401(k)s to an IRA if for no other reason than to consolidate and simplify. As an advisor I generally have access to low cost share classes (institutional, etc.) and as you said our investment universe is often greater.
As far as the fee issue I’d add this point. Some 401(k) plans (generally with larger employers) use ultra low cost institutional index funds and these might make it worthwhile to stay with an old plan. The flip side is that far too many plans have excessive administration fees that are paid by the participants, these are plans where rolling over is the best move.
A couple thoughts on this. If you separate from your company at age 55 or later, you are able to take withdrawals with no penalty. For IRAs, it’s 59-1/2, without jumping through the Sec72(t) hoops.
If one has substantial non-deducted IRA deposits, it may be wise to convert to Roth the year prior to moving the 401(k) to an IRA. This avoids the rules regarding prorating the pretax funds when converting. This maneuver can help avoid a larger tax bill on conversion.
With my last 401k, I became tired of the funds that were used. I thought that my IRA options had better choices. My old employer also made changes to the fund that I wasn’t pleased about and drop my growth index fund that I’d been investing in.
Thanks to share detailed information about 401K. There is a huge list of employees who are not familiar with 401k, on the other hand some don’t know benefits of its. It is helpful for me as well.
If I’ve found a low-cost, good performance IRA, I’ll nearly always roll it over. I’ve met too many people with four old 401k plans. Who can keep track of all these different little accounts?
Getting to 4 older 401k plans is a bit much, but you do have a point. This article was written with the 1 401k plan / 1 job scenario in mind. My thinking is, if you love the new 401k plan so much you would have rolled the assets there to begin with.