What To Do With 401k at Former Employer
One of the last things people think about when they are looking at making a career or job change is what to do with their 401k if they leave. Unfortunately, many employees make a poor choice instead of considering other smarter alternatives. Perhaps they are not aware of their options.
You have four options:
- Leave it with old employer’s plan
- Move it to new employer’s plan
- Roll into an IRA
- Cash it out
We can easily eliminate one option – DO NOT cash out your 401k unless you are in desperate circumstances. Why? Because it is expensive – you will pay taxes at ordinary income rates on the distribution AND a 10% tax penalty. It’s hard to conceive of many financial circumstances so desperate to suggest that this would be your best option.
So now that we’ve eliminated one of the options let’s look at the other three options and look at pros and cons for each to help you determine what you should do.
Leave with Former Employer: The downside of leaving money in a former employer’s plan is a function of the fact that you will need to continue to have online access. In my experience many investors have a difficult time managing multiple logins and coordinating the asset allocation across the new employer plan and old employer plan. In addition, you are not likely to get much help from the financial advisor who is being paid by your old employer. But the biggest “con” of keeping money in an old plan are the challenges which come when an employer is either acquired or goes out of business. In some cases, acquiring companies do not want to continue a 401k plan and so assets are “orphaned”. In other cases, the acquiring company is later acquired - and after a couple iterations it becomes very difficult to track how to access your accounts or for that matter find the HR department that is familiar with where your 401k assets are held. Not good.
The potential “pro” of keeping many in your old employers’ plan would be if your former employer had a very low-cost plan and you are invested in a low-cost target retirement date fund. This would allow you to feel confident that the funds are going to always be invested appropriately given your age. But again, in my opinion low costs in the case of a 401k are often outweighed by the risks of having money in a plan for a company you no longer have any ties to.
Roll into New Employer Plan: The only potential downside of rolling money into a new employer plan are if the plan is higher fees than former employer 401k or if the new plan has weak/expensive investment options and/or low-quality advice. There are no taxes due for rolling the money over. In addition, you consolidate your money so it’s easier to track. Again, the primary considerations for rolling the money into a new employer’s plan is the ease of tracking assets with a secondary consideration being the comparison of fees, investment options, and advisor support for the plan.
Roll Into IRA: This may be the best option for most participants who separate from employment. You should find an experienced fee-only advisor who is committed to using low-cost investments. You will certainly get the most customized help and usually better funds than relying on the default options of your former employer’s plan. In addition, the advisor will likely be able to help you with questions about your progress towards retirement and steps you can take to improve. They may also help prepare a financial plan and provide some expertise in social security as well as point you to skilled estate planning professionals.
It’s difficult to make a blanket statement about which of the three options is always best.
If you are confused or feel like you could use some help – contact your financial advisor. If he can’t or won’t help - get yourself a new advisor or feel free to reach out to me to discuss.