What should you do with your old 401k?
–Jennifer Baham, CFP™
You’ve left your job and now have a 401k plan that you can no longer contribute to. What should you do with it? You have several options to consider:
- Roll over to an IRA – this preserves the tax-deferred status of the assets, without paying taxes or early withdrawal penalties at the time of transfer. You may have to pay a management fee if the IRA is actively managed, but you are likely already paying administrative fees to the 401k plan administrator. You will likely benefit by having more investment choices to pick from in an IRA, as most 401k plans have limited investment choices. It’s worth noting that some 401k’s allow you to borrow against them, whereas IRA’s do not. Something else to consider– IRA’s and 401k’s have slightly different early withdrawal rules. Under normal circumstances, there is an early withdrawal penalty if you are under 59 ½ for either account type. However, if you leave or lose your job before you reach 59 ½, then you may qualify for the IRS rule of 55. This states that if you turn 55 or later during the calendar year you lose or leave your job, you can take distributions from your current 401k without paying the early withdrawal penalty. There is a subset of rules to this rule that we won’t go into in this article. If this is something you are considering, be sure to review the IRS’s guidelines.
- Leave the money where it is. You may find that as a former employer, it could be harder to get communications regarding your plan as news is often distributed through company email. It is also common for people to lose track of their old plans and you may be less likely to monitor the investments and make changes.
- Rollover the money to your current 401k (if that is permitted by the plan). This allows you to consolidate the plan. You should review the investment options and fees of the new plan compared to that of an IRA.
- Take a cash distribution. If you do this, you will owe income tax on the money and may also be subject to a 10% early withdrawal penalty if you are under 59 ½. Your employer is also required to withhold 20% for taxes. There are some IRS exceptions for this so be sure to check current rules. You will also lose out on potential investment growth of the funds.
- Convert to a Roth IRA. The process is similar to rolling the funds to an IRA, but you’ll have to pay taxes on the money you convert. Roth IRA’s are funded with after-tax dollars, while traditional IRA’s are funded with pre-tax dollars. Unlike traditional IRAs, Roth IRA’s don’t have Required Minimum Distributions (RMDs). Roth IRA’s can be very valuable, as earnings grow tax-free, and as long as the Roth has been open for at least 5 years and you are 59.5 years old, withdrawals are tax-free as well.
When weighing your options, it’s important to consider your long-term goals for the funds. Your tax and (Harbor) financial advisors can help you strategize which option is best for you.