401(k)s are one of the most common retirement plans in the United States. Many employers offer them as an employee benefit and will offer to make additional contributions on your behalf.
Because 401(k)s are offered by employers as a benefit, that means that your 401(k) is tied to your employer.
You cannot open a 401(k) on your own, and if you move to a new company, you’ll need to start using their 401(k) if you want to save for retirement.
That leaves the question: what do I do with my old 401(k)? If you’re moving to a new company and want to do something with your 401(k), you have a few options.
1. Roll Over Your Retirement Plan
One option that you have is to roll your old retirement plan into a new account. You can roll your 401(k) into an IRA of the same type.
So, if you have a traditional 401(k), you can roll the full balance into a traditional IRA.
If you have a Roth 401(k), you can roll the balance into a Roth IRA.
If your new employer allows it, you can also roll your old 401(k) into your new 401(k).
This is a good choice because it lets you maintain the tax advantages of the 401(k). Early withdrawals from retirement accounts can result in hefty penalties, and taxes can cost a lot.
Keeping those tax benefits can help you maximize the value of your 401(k).
How to roll over your old 401(k)
When you want to roll your old 401(k) into an IRA or your new employers 401(k), you need to follow the process carefully.
Failure to follow the process properly can trigger early withdrawal penalties.
When you begin a rollover, you have 60 days to complete the transfer from the time you withdraw the money from the account. If you take longer than 60 days, the withdrawal will be treated as an early distribution.
You’ll have to pay any applicable taxes, plus a 10% penalty on the amount you withdrew.
The best way to avoid this is to initiate what is called a trustee-to-trustee transfer.
With a trustee-to-trustee transfer, you’ll contact the financial institution that you’re transferring the money to.
The receiving institution will tell you what you need to do to get the money into your new account. You also need to contact the company that maintains your old 401(k). Explain that you want to do a trustee-to-trustee transfer.
Your old employer may withhold up to 20% of the balance of your 401(k) when you do trustee-to-trustee transfer, to account for taxes.
- If you can, waive this withholding and transfer the full amount.
- If you can’t, use your own money to make up the difference by sending it to your new account. You’ll get the withheld money back when you file your income taxes.
Once you fill out all the paperwork, the money will be moved directly from the old account to the new account.
You never see the money physically, so there’s much less risk of delays and exceeding the 60-day limit.
Move to an IRA or new employer’s 401(k)?
In the vast majority of cases, it is better to roll your old 401(k) into an IRA. Most 401(k)s only allow you to invest in specific mutual funds offered by your plan. You can invest in anything you’d like in an IRA, so IRAs are much more flexible.
The one reason you’d want to roll your old 401(k) into your new 401(k) is if it offers the mutual funds you want, but at a lower expense ratio than would be available in an IRA.
Some large companies offer institutional mutual funds with come with very low expense ratios.
2. Cash Out Your Retirement Plan
When you leave your old employer, you have the option of cashing out your retirement plan. This is generally a bad idea because of the costs involved.
One of the reasons that you get tax benefits for saving in a 401(k) is that you promise not to use the money until you reach retirement age (59 1/2).
If you break that promise, you have to pay a penalty.
Specifically, you have to pay income tax on any of the funds that you withdraw. You also have to pay a 10% penalty on the amount withdrawn.
Ignoring the upfront cost, you also have to take into account the fact that you’re reducing your retirement savings when you cash out. That could lead you to a situation where you want to retire but don’t have enough money to do so.
3. Leave the Money Where It Is
If you have at least $5,000 in your old retirement account when you leave your job, you have the option of keeping your money in the old account.
You won’t be able to add more money to the account, but you can leave it to continue to grow. If you like the investments available in your old 401(k), this can be a good option to choose.
One of the downsides of this is that it can be hard to keep track of all of your retirement accounts. If you change employers very often, you could wind up with a number of 401(k)s to keep track of.
Sometimes, your old employer will change 401(k) providers, and your money will move to the new provider. You’ll have to keep very close track of all of your accounts to make sure you don’t forget about any.
Watch Out for Fees to Keep the Old 401(k)
If you do want to keep your old 401(k) open, make sure to read the plan documents closely. Many 401(k)s have rules and restrictions surrounding accounts held by former employees.
Your old 401(k) might charge additional fees to keep your account open. Even small fees can add up to significant amounts over time.
You might be able to avoid these fees if you have enough money in your old account, but remember that you won’t be able to add to it anymore, making it hard to reach that point if you aren’t there yet.
Also, remember that the expense ratios on your investments are like paying a fee.
If you can get a lower expense ratio on an equivalent investment by rolling the money into a new account, consider the opportunity cost of not going through the rollover process.
Can You Still Borrow From an Old 401(k)?
Though your 401(k)’s balance is intended to be used for retirement expenses, there are ways to get access to the money sooner. One option is the 401(k) loan.
When you borrow money from your 401(k) the money is taken out of your investments and deposited to your checking account. You lose out on potential investment growth during this time.
You have to treat the money like a normal loan. There’s an interest rate on the loan and monthly minimum payments to make. Missing payments incur penalties.
Even though you’re paying interest to yourself, taking out a 401(k) loan usually results in a lower 401(k) balance due to lost investment gains.
There’s also the danger that you’ll be forced to pay the loan back in full before you expect to. If you lose your job, the full amount of the loan must be paid back immediately, which can be difficult to do if you don’t have the cash on hand.
That being said, it is exceedingly rare for a 401(k) plan to allow previous employees to take out a 401(k) loan.
If you need to get money out of your old 401(k), you’ll need to cash it out, which incurs significant penalties or roll the balance into your new 401(k).
Once the money is in your new account, you can get a 401(k) loan.
What Happens to Your 401(k) if Your Old Company Shuts Down?
Once you are vested in your 401(k) all of the money in the account belongs to you. Your old company cannot take the money, even if goes bankrupt or closes for some other reason.
If your old company closes and you still have your old 401(k), the plan will almost certainly be shut down.
You’ll need to either cash out your money, and pay the applicable taxes and penalties, or roll the balance into an IRA or your new 401(k).
It is very important that you keep track of your old 401(k)s.
It’s also important that you keep the plan administrator updated on how to contact you.
If you lose track of an old 401(k) and the company closes, you might not hear about it until it’s too late. At that point, the money in the plan will have been cashed out and you’ll be forced to pay the taxes and penalties.
There are many things you can do with your 401(k) plan when you leave an employer, but the best choice is generally to roll the balance into an IRA.
This gives you more flexibility to choose investments and lets you maintain the tax advantages offered by the retirement plan.