What Does Rolling Over a 401(k) Mean?
We get this question a lot: If I decide to leave my job (for reasons other than retirement), what do I do with my 401(k)?
Well, you actually have several different options to consider.
When managing your own 401(k) plan, deciding what’s best for you can be confusing. As with most financial decisions, there is no one-size-fits-all approach, and the decision that’s best for one person may not be right for you.
At Scarborough Capital Management, we specialize in 401(k) plan management. There are 4 common methods for dealing with a 401(k) as well as pros and cons to each.
Before you decide what to do with your 401(k), it’s important to consider your age, your retirement plans and your overall financial situation. Determine the balance of the 401(k) you had with your former employer, look at the costs and features of other plans available to you both privately and with a new employer and learn about how 401(k) rollover works.
Option 1: Maintain the 401(k) With Your Old Employer
If your former employer allows you to keep your current 401(k) plan after you leave the company, and if your current 401(k) is a better plan than one your new employer may offer, it can be advantageous to maintain your current 401(k) with your former employer. This is especially true if your current 401(k) plan has consistently performed well, has lower fees than other retirement plan options, or if you are leaving your current job to work for yourself or another business that doesn’t offer a 401(k).
If you have more than $5,000 saved, you’ll likely be allowed to keep the account after you leave. If you have less than $1,000, you may be forced to cash it out. If your balance is somewhere between $1,000 and $5,000, you will need to notify the plan administrator of your desire to stay with the plan; however, your company may require you to move it, in which case they are required to help you set up an IRA to roll your funds into.
One downside to maintaining your old 401(k) is that you’ll no longer be able to contribute to the account and therefore, will not be eligible for any employer contribution matching.
Option 2: Roll Over Your Assets
If you decide to take the money out of the 401(k) you had with your former employer, you can put it into another retirement plan, like a Traditional or Roth IRA, or another 401(k) (more on that below). This is known as a 401(k) rollover. There are a number of reasons to consider rolling over your 401(k), like more investment choices, lower fees, fewer or different plan rules and more flexibility.
An IRA gives you more control and more investment options. Typical 401(k) plans offer less than 100 investment options. Most IRAs have access to thousands. So tailoring a plan to your specific needs could be easier in an IRA. Some investment options available in an IRA may also have fewer or lower fees than the investment options in your current 401(k).
With a Traditional IRA, the contributions are pre-tax, but distributions are taxed. With a Roth IRA, contributions are made after taxes, there’s tax-deferred growth, and tax-free distribution in retirement.
If you decide to roll over your 401(k), let the plan administrator from your former employer’s 401(k) plan know where you’ve opened your new account. The administrator will then either transfer the funds into your new account (a direct rollover) or mail you a check (an indirect rollover), which you’ll then have to deposit into your new account.
According to IRS regulations, once you receive an IRA or retirement plan distribution, you only have 60 days to roll it over to another IRA or retirement plan, so make sure the new account is ready to go before you close your old account. If you need help, discuss your decision with your financial advisor.
Compare the costs and fees related to the new plan you’re considering. If the fees are higher than your current plan with your former employer, you may want to reconsider whether the benefits of rolling over your 401(k) make the most financial sense.
The tax implications for a rollover can be confusing, but as a general rule, you should be in good shape if you move funds between similar accounts that have similar tax rules (like a Roth 401(k) to a Roth IRA). If you roll a Traditional IRA (which you contribute to with pre-tax dollars) to a Roth IRA (where contributions are taxed but withdrawals are often tax-free), you may have to pay taxes on the amount you’re transferring.
Option 3: Consolidate With Your New Employer
If your previous 401(k) doesn’t have a big balance, you may forget about it or be overwhelmed with keeping track of multiple accounts. If you find yourself in this situation, you may want to roll the funds over to your new employer’s program, if one is available.
Be sure to research your new plan’s rules and investment options before making your decision because the funds will be subject to the new plan rules and investment options.
In addition to helping streamline your retirement accounts, rolling over a 401(k) from your former employer to your new one may also help grow your balance faster if your new employer offers contribution matching.
If the new 401(k) program is cost-effective, consolidating your 401(k) with your new employer may be the simplest solution. As long as you rollover assets from one 401(k) to another 401(k) plan directly, you can avoid potential taxes and penalties.
Option 4: Take the Cash Out
Cashing out your 401(k) would give you immediate access to the funds. Though withdrawing the money as a lump-sum isn’t usually an ideal option, because of the tax implications: You can be taxed on the 401(k) funds as regular income, and if you’re not at least 59-½ years old, you can also be penalized for taking an early withdrawal. Who wants to lose a big chunk of their hard-earned savings to taxes and penalties?
Which is Right for You
All of the above options have strict rules and considerations. If you want to learn more about the pros and cons of a particular plan, if you’re not sure which of these rollover options is the best fit for you, or if you don’t know how to start the process to roll over your 401(k), discuss your options with a financial advisor who specializes in 401(k) plan management to help you make the most informed decision.
At Scarborough Capital Management, we work with a lot of young professionals who are just getting started. If you know you don’t want to take on managing your own 401(k), contact us to see how we can help.
Securities through Independent Financial Group, LLC (IFG), a registered broker-dealer. Member FINRA/SIPC. Advisory services offered through Scarborough Capital Management, a registered investment advisor. IFG and Scarborough Capital Management are unaffiliated entities.