Question: I left my previous employer and have an old 401(k) retirement account which I haven’t touched. I have received different suggestions on what to do, but I’m not sure what my best option is. What do you advise? – Sarah Melnick Fulop, West Hempstead, NY
This is one of the most common, and also one of the most important, financial planning questions I receive. While the question referred to a 401(k), the same advice can apply to readers with all types of defined contribution plans such as a 403(b) or 457(b). All of these are an employee’s retirement account through an employer whose contributions are made from their paycheck.
If you spent many years working for a company, it is possible that this pool of money is one of your most significant assets. Therefore, proper management of these funds is foundational to a successful retirement. Below I outline some of the most important points to help guide your decision.
Do NOT move this money into a taxable account: This point may seem obvious to many, but I am astonished by how many sophisticated people tell me that after leaving their previous employer they moved all their retirement funds into their checking account. This is a huge mistake. That move is likely to cause the investor to pay taxes earlier than otherwise required and may also trigger a larger overall tax bill. It may also cause penalties if the funds were moved out before age 59 ½. B’kitztur: Avoid this approach!
Make sure to keep the money in an account that has the same tax treatment: The two different methods of being taxed on retirement funds are described in retirement lingo as “Traditional” and “Roth.” In traditional funds, contributions are made with pre-tax dollars, the investor receives a tax deduction, the money grows tax deferred, and the investor pays ordinary income tax on the money withdrawn during retirement. For a Roth account, investors put in after-tax dollars, the funds grow tax deferred, and the investor does not pay tax on these funds when they take it out in retirement.
There are merits of each approach, but that’s a whole topic for another day. For this discussion, just be mindful that Traditional funds must be kept in either a Traditional IRA or Traditional 401(k) account and Roth funds must remain in a Roth IRA or Roth 401(k) account. You may also have both pre- and post-tax dollars in your 401(k). The key is to make sure they maintain the same status regardless of what you do with the money.
Do nothing and keep the money where it is: This is the default approach since it requires no effort. However, there is rarely a compelling reason to keep your retirement assets at an old employer. The one exception is if you have an outstanding loan balance on your 401(k) or may want to borrow against these funds in the future. In that case, wait until it is fully paid off before moving the money to avoid complications when consolidating your funds. I’d be remiss not to note that borrowing from your 401(k) should always be a last resort since it derails your ability to retire.
The drawbacks of 401(k) plans are their generally very limited investment options and lack of a personal advisor to help manage your investments based on your goals. Investors who leave funds in old 401(k) plans typically find themselves approaching retirement with a smattering of old retirement accounts from previous employers that have an incoherent investment strategy. It’s a cumbersome mess that makes planning for retirement more difficult. It behooves most investors to take 15 minutes to move these funds to keep their financial life organized. As I tell my clients, “Doing nothing is a decision, and it is usually the wrong one.”
Move the money into your current employer’s retirement plan: Some job changers will decide to “rollover” their old 401(k) assets into the 401(k) at their new employer. The benefit of this approach is their retirement assets will be consolidated in one place, making planning for retirement easier. The downside is the funds are then kept in a 401(k), whose two main drawbacks are limited investment options and lack of personalized advice I noted above.
Please note, whenever you move your 401(k) make sure the beneficiary information on the account is updated. Every financial advisor can share horror stories of investors who never updated their beneficiaries, so their retirement dollars went to people they did not intend (e.g. an ex-spouse!). All investors should review their beneficiary designations annually to make sure they align with their intentions.
Move money to an IRA that you manage: Switching companies is a wonderful opportunity for DIY (“Do It Yourself”) Investors to move the funds into their own IRA where they can manage it according to their wishes. If you are the type of person who enjoys selecting and managing your own investments, this is a great opportunity. Furthermore, if you have other retirement assets, you may be able to consolidate various old retirement funds all into one account to keep your financial life more organized.
Be mindful that you have 60 days from issuance to deposit the rollover check into your IRA. Taking longer than 60 days to deposit will result in taxes and penalties.
Move money to an IRA managed by your financial advisor: If you work with a financial advisor, or would like to, then it is often sensible to consolidate these retirement assets along with all your other investments under one umbrella overseen by this individual. This allows your advisor to see your full financial picture and gives them the ability to seamlessly manage and track your investments. Most reputable advisors have access to a plethora of investment options (and are not just looking to push certain funds), and can advise on what makes the most sense for your specific situation and how this new money impacts the rest of your financial life. Naturally, there will be fees associated with this relationship. Every investor needs to decide if paying for professional advice makes sense for their own specific situation.
There are a variety of other nuances to consider before moving your 401(k), but the aforementioned points are the most important factors. If you don’t know which option is the best for you, feel free to reach out to me directly for some guidance. This decision is far too impactful to leave to chance.