What To Do With Your 401K When You Leave Your Employer
When you leave an employer, you generally have four options for your 401K:
- Bad idea: Leave the funds with your ex-employer’s 401K.
- Worse: Roll over the funds into your new employer’s 401K.
- Worst: Cash it out.
- Best: Roll over the funds into an IRA.
Choose door #4.
#1 is bad. You’re stuck with your ex-employer’s plan and it may have high fees or unsuitable investment choices. Even if your plan is well-managed, there are additional reasons to choose #4 that I’ll mention below.
#2 is worse because once you roll over funds into a new 401K, you’re committed to your new employer’s plan for as long as you’re working there. At least with #1, you retain the option to do #4 at a later date.
#3 is the worst because by taking a cash distribution, you’ll spend the money, pay penalties and taxes, and lose the retirement savings you worked so hard to accrue. Don’t be tempted by the shiny apple.
#4 is best because with an IRA, you control the two critical dimensions of fees and investment choices. You select the financial institution to use and the fund to invest in. Do #4 every time you leave an employer.
There are additional reasons to do so.
- Minimize complexity. When you reach a certain age, you don’t want a folder full of old 401K statements. Keeping track of them complicates your life with no compensating benefit.
- Easier to manage. With a Traditional plan, required minimum distributions are easier to administer if you only have one retirement account (i.e., a single IRA) from which to take them.
- Roth conversion option. You may want to do a conversion from a pre-tax IRA into a Roth in the future. This is easy to do with an IRA but may not be possible from an old 401K.
Keep it simple throughout your working career. Every time you change employers, roll over your 401K into your existing IRA.
PS: Keep in mind… A Roth 401K always rolls into a Roth IRA; a pre-tax 401K always rolls into a pre-tax IRA.