Left your job or old 401(k): Now what?

Old 401(k) or 403(b)? Follow Me!

[Updated on 08/01/2022]

This post on what to do with an old 401(k) was featured by:
•Physician on FIRE in the Sunday Best series on 11/28/21
•Personal Finance Blogs in the daily Personal Finance Features on 12/1/21
•Budgets Are $exy in the 401(k) Champion Awards recap on 12/14/21, where Joel described it as,”[A] great resource for any of you switching jobs right now”
•Apex Money in the Powerful lessons from growing up in public housing projects email on 4/21/22

[Note: For the sake of this post, we will refer to all Defined Contribution plans, such as 401(k), 403(b), PSP, RSP, TSP, & ESOP’s, as 401(k) plans. Please note that you can read the website disclosure statement here.]

Today’s Mission: Determining what to do with an old 401(k) plan

Months ago, I would often get asked the question, “What should I do with my old 401(k) plan?” At the time, I was working full-time as a retirement planner for one of the US’s largest brokerage and investment advisory houses.

Now, many people think you have to roll over a 401(k) plan once you leave a job, but to the contrary, the question (generally) is whether you should roll it over. And importantly, the answer will never be the same as it is dependent upon your unique situation. 

Thus, to decide whether or not a rollover is warranted, we must explore the choices available to us! So, when you leave a company, (generally) you will have four options, which include:

1. Staying in your 401(k).
2. Moving to your new 401(k).
3. Rolling to an IRA.
4. Cashing out your 401(k).

Now for this post, we will assume you have no need to cash your account out, and yes, there are reasons you would do that, which I will detail in a future post, but we will be exploring options one through three today.

An Analogy

I have always described choosing which account to choose for your retirement funds as similar to selecting the right backpack. For example, you wouldn’t take a day pack on a fifty-mile expedition, just like you wouldn’t take a rigid frame, backcountry pack to the coffee shop. 

Therefore, it is essential to select the proper account for your situation when determining what to do with your old 401(k). But, what are the criteria for determining what matters most to you? Well, the best choice ExPLORES all of your options!

Ex-P-L-O-R-E-S

(Clickable table of contents)
Expenses: The Fees & Costs
Protections: ERISA & You
Liquidations: Distributions & Loans
Options: Available Investments
RMDs
Ease: Simplicity of Management
Services: Features & Personal Preferences

[Important Note: Please keep track of which options matter most for you as you read, marking +1 for either 401(k)s or IRAs as you progress. Doing so will make it easier to summarize what options your explored are important. Then, at the end, you can add up the sum for 401ks and IRAs to see which account works best for you! Importantly, this may be different for each 401k and IRA account you have, so keep track of your various providers if you have multiple. ]

Expenses: The Fees & Costs

For the first section, you have to ask yourself what fees do the account and investments have?

Some 401(k) plans will charge an account fee covering the costs of running the 401(k) plan, while many IRA providers do not (but not all). Why? Because with 401k plans, the employer must keep it in compliance with the many federal requirements. Thus, administrative work costs money, plus the burden of paying for customer service falls on the employer, not the 401(k) provider.

So, shop around and see the basic cost of an account at each of the companies you are considering, then weigh if they matter to you.

The next question regarding expenses is how much do the investments offered in your 401(k) cost? I.e., the expense ratios. 

If you are unsure what an expense ratio is, you can read this brief introduction here. Notwithstanding, in a nutshell, an expense ratio is the cost to operate a mutual fund. After all, mutual funds are companies that specialize in either growing or protecting your money. Thus, an expense ratio comprises of the costs to keep the lights on and the business running! 

Notably, many 401(k) plans (but not all) offer discounted expense ratios on investments. These discounts are provided because the mutual fund provider is willing to accept less profit per person in return for more people buying it (think Costco or Sam’s Club and how consumers buy in bulk but have limited choices). 

Quick note: Generally, from my personal experience, the bigger the company you work for, the less expensive the investments offered will be! 

Now in IRA accounts, you are buying as a regular consumer, meaning you do not have the purchasing power of an entire company’s employee base – unless you are Elon Musk or Jeff Bezos. As a result, you will pay the standard (and potentially higher) expense ratio for investments. However, you are not locked into limited investment choices like the prior.

In closing, decide how much these expenses matter to you, and then move on to the next leg of our journey: protection!

Protections: ERISA & You

Generally speaking, 401(k) accounts offer unlimited protection from creditors due to ERISA, the Employee Retirement Income Security Act. What does this mean? Essentially, if someone tries to sue you and your assets are in a 401(k), they are out of luck, including debt collectors. And while 401(k)s are tied to specific companies, these assets are separate, meaning that if a company goes bankrupt, your money does not disappear with it.

IRAs, meanwhile, typically only offer protection in bankruptcy cases. However, some states provide expanded creditor protections for IRAs, but I am not a legal guru, and there are fifty states. So, if this matters to you, read up on your local laws or get professional advice!

Notably, some 403(b) plans are exempt from ERISA, meaning they do not offer creditor protection. If you are unsure if your 403(b) plan is exempt, call your plan sponsor to find out. Additionally, here is an article by TIAA discussing the subject.

Liquidations: Distributions & Loans

We have now evaluated fees and protections, so we can move on with discussing liquidations. This section boils down to how different retirement accounts allow you to access your money. Why does this matter? Well, some accounts allow you to take liquidations (i.e., withdrawals) through installments or partial payments, while others simply offer one-time payments. Thus, it is essential to ask your account provider what options they provide and evaluate what you need. 

Notably, any withdrawals by those under age 59.5 from qualified retirement accounts will be assessed taxes and a 10% early withdrawal penalty unless they have an exemption. Essentially, the penalty is Uncle Sam’s way of telling you not to touch the money unless you absolutely need it. 

What if you don’t want to pay the penalty? Well, here is a shortlist of opportunities to help inform you:

•401(k)s generally allow you to take a loan against your balance, and if you repay it, there are no taxes or penalties. Notably, not all 401(k)s provide loans, and generally, they are only available to actively working employees
•Retiring the year you turn 55 (or older)? With 401(k)s, you can withdraw penalty-free when you leave that company the year you turn 55 or older
•Having a child or adopting? 401(k) and IRA plans (can) allow for withdraws for up to $5,000 without penalty
• First-time homebuyer? With IRAs, you can withdrawal $10,000 without penalty to help facilitate the purchase without penalty
•Need money for higher education for your dependents or self? With IRAs, you can withdrawal an UNLIMITED amount without penalty
•Do you own company stock in your 401(k)? Then Net Unrealized Appreciation could be worth considering. NUA is a complex topic outlined here. However, its basic concept is the ability to (potentially) arbitrage your tax brackets. This arbitrage means splitting your tax burden between ordinary income and capital gains tax rates. As a result, NUA can create an overall lower tax rate on your retirement dollars. Notably, the ordinary income portion can be penalized without an exemption but, the long-term capital gains piece never is
•Do you have significant medical expenses? Then you can potentially withdraw from a 401(k) or IRA and only pay taxes 
•Did you receive this 401k from your spouse due to a Qualified Domestic Relations Order? Then any withdrawals you make from this 401k are be penalty-free! These accounts are known as QDROs

For those curious, I have written an entire article on penalty-free withdrawals from 401(k) and IRA plans, located here.

Options: Available Investments

Are you hanging in there? We have now assessed which distribution options matter to you. So, tighten the laces on your hiking shoes, and let’s continue our trek! 

As alluded to earlier, different retirement accounts offer different investment choices, with some having limited options and others offering a plethora. However, these investment choices may or may not matter, as it boils down to how you want to manage your money. 

If you are a self-directed investor, you likely know which investment options matter most to you. Thus, you should ask yourself, does my old 401(k) plan offer me sufficient choices? If the answer is no, then the 401(k) may not be suitable for you. However, a simple glance should be done to check if any unique investments exist, such as stable value funds or access to closed mutual funds (this applies to non-self-directed investors, too). 

If these unique investments matter, definitely take note. Now, suppose your old 401(k) or new one does not offer unique investments or ones that are sufficient. In that case, an IRA could be a viable alternative since IRAs generally offer expanded investment choices, including stocks, bonds, mutual funds, ETFs, options, and other financial instruments, such as annuities. 

[Unique investments, such as stable value funds, pay higher interest rates than money market funds or CDs and are only offered through 401(k) plans. Other examples of unique investments include hedge-fund-like products that regular investors cannot access without a 401(k) or access to closed mutual funds.]

If you are not a self-directed investor and want to be hands-off with your savings, this next section is for you. The question that will decide which account is more viable is, “Do you want your money professionally managed around your situation for an added fee? Or do you want an automated investment that won’t be tailored to your specific situation but does the work of lowering risk over time automatically?” 

[If you need help deciding, I will create a future post that outlines the pros and cons of each. My specific preference is automated, but yours may not be.]

If you decide you want a managed solution because of your situation, see which accounts offer them and which one makes you feel the most comfortable. Management could be available your old 401(k), new 401(k), or IRA account. However, it could also be just the IRA account. Additionally, each provider may manage your money differently based on the account type, so don’t hesitate to ask for a proposal so you can compare them all. You should make sure to understand any and all costs associated with professional management. There is a reason why many shun managed accounts, and hidden fees are a contributing factor. Thus, ask the provider to be transparent about the management fee, exchange fees or loads, expense ratios, and any other assessable fees.

Suppose you go with an automated investment, such as a target-date retirement fund. First, look at the different target-date funds offered between your old 401(k), new 401(k), and IRA accounts, and then compare them to see which one you like the best! In this case, weighing the investment cost and its performance track record to other target funds will serve investors best. Personal preference to fund managers or companies can also play into decisions here. However, indexed target-date funds are my preference.

RMDs

Required minimum distributions, what does that even mean? It sounds strange, doesn’t it? 

Well, these are mandated distributions that one has to take. This section only matters if you are approaching the age of 72 or are already taking these withdrawals. Known as RMDs for short, these are withdrawals Uncle Sam makes you take once you attain the age of 72. Essentially, they are sick of waiting for their cut of your tax-deffered dollars. Just like how you worked hard to grow this money, Uncle Sam thinks he has worked hard not to touch it! 

Jokes aside, RMDs work differently depending on the type of retirement account you have. With 401(k)s, each 401(k) account has to have a withdrawal taken from it, each year. So if you have five 401(k)s, you take five withdraws. 

With IRAs, you can combine the total amount needed to be withdrawn from all traditional IRAs, then choose to withdrawal that sum from one of them. For example, if you have five IRAs, you can take the total RMD amounts from one of them. This is because with traditional IRAs, the government views them all as the same IRA, even if they are held at different companies.

Notably, Roth IRAs have no RMD since all taxes have been paid.

Fun fact alert! Combining RMDs applies to 403(b) plans, too, as the IRS allows all 403(b) RMDs to be aggregated. This is one of the few times 403(b)s are different than 401(k)s. 

Now if you are still actively working and your company offers a 401(k) plan, moving your old 401(k)s and IRAs into it can be a great option if you are not ready to take these required distributions. This is because the government recognizes that you do not need the income and is kind enough to let you defer it! However, if you happen to be a big wig and own more than 5% of the company, this does not apply to you and you will have to take the RMD.

Lastly, with 401(k) accounts, if you have Roth dollars in them, you must take an RMD from the total value, including these dollars. Thus, it can be preferable for those without the need for income to roll out Roth 401(k) dollars, if allowed.

Ease: Simplicity of Management

Whoa! We have now reached the second to last category, and it entails simplicity and ease of management.

When it comes to keeping track of your savings, the more accounts you have, the more complicated things feel and look. You must track the performance of each and make sure you are using the best investment and withdrawal choices from each account. Thus, in other words, it requires more effort on your part. 

Suppose you are someone who will not stay on top of two, three, or four plus accounts. In that case, consolidating into a 401(k) or IRA could make sense. However, if you are a detailed oriented person, this may make no difference. Instead, you may prefer the unique benefits each account affords.

In closing, choose the approach to management that matters to you. Some people like simplicity and ease of management, while others are spreadsheet optimizers!

Services: Features & Personal Preferences

We have made it to the final category, and the focus is on the services an account provides you, which are essentially the available bells and whistles! 

Ding ding! Whistle whistle! 

Now, services provided with an account will vary greatly depending on the provider and the specific account type. So, this section will act as a brief preface to the subject since there is no way to discuss it concisely. Thus, ask the different providers you are evaluating what services are available and then determine if they matter. 

Below are the most common services offered with different accounts:
•Some 401(k)s offer general financial planning at no added cost for you as a participant
•With some IRAs, retirement income planning is provided at no extra cost
•With some IRAs, premium client tiers exist if you have enough money
•With some IRAs, joint banking and investment houses will offer access to discounted mortgage rates 
•Wire transfers, check writing, and debit cards are available with many IRAs, but not with 401(k)s

Notably, some people have personal preferences when it comes to firms. Do you happen to believe that a specific investment company is better due to how they operate or subjectively make you feel? Does that opinion make you likelier to entrust them with your money? If so, that is a fair consideration. 

Everyone under the sun has their reasons as to what company is best for [insert example]. Some reasons include the features certain companies provide, while others are due to specific company mission statements. Boggleheads will tell you there is only one place to invest, while others may preach about the customer service XYZ firm provides. Remember, though, if a particle service, feature, or business model matters to you, evaluate it when deciding between accounts. 

Summit Reached: Conclusion

Okay, that was quite the hike, with some treacherous moments. It may have required some additional reading, or it could have been a refresher on things you already knew. Regardless, we summited the mountain of financial knowledge regarding old 401(k)s and what to do with them. And, while there are many considerations, remember to choose what works best for you.

So, let me know in the comments below which account type you prefer. Is it 401(k)s, or perhaps IRAs? Regardless, I would love to hear your reasoning, and as always, have a great day!

Important note: If you have a more complicated situation, such as you do back door Roth IRA conversions, your 401(k) is being eliminated, you have multiple RMDs, you need to withdrawal money now, or are concerned about creditors, seek out the appropriate tax, financial, and legal advice from experts.

FAQ: 

What is the best thing to do with 401k?

When you work for the company, contributing up to at least the company match and investing your funds so they grow! Once you leave, it depends on your situation, but leaving it in that 401(k) plan or rolling it over to a new one or an IRA could make sense.

What is the best thing to do with my 401k when I leave my job?

It depends on your situation, but leaving it in that 401(k) plan or rolling it over to a new one or an IRA could make sense. Using my guide outlined in this post should provide you with guidance on which option could make the most sense for you.

Does rolling over money from a 401(k) to a new 401(k) or IRA incur taxes or penalties?

Simple answer: No. Expanded answer: No, rollovers do not incur taxes unless you default on an outstanding loan from your old 401(k) plan when you do the rollover. 

Can I roll to an IRA and then back into a 401(k)?

Simple answer: Generally, you can. Expanded answer: Generally, you can move from a 401(k) to a rollover IRA and then back to a new 401(k) but, always check with the company that administers your new or old plan to see if this is allowed.

What happens to Roth 401(k) dollars when rolled over?

If you roll over Roth 401(k) dollars to another 401(k), they can then move to another 401(k) in the future, generally. However, once you roll over Roth 401(k) dollars to a Roth IRA, you cannot roll them back into a 401(k) plan. Once a Roth IRA, always a Roth IRA.

Can I roll my traditional IRA into a 401(k)?

Sometimes! Check with the company that administers your 401(k) plan to see if they will accept the money as a roll-in from a traditional IRA. Generally, rollover IRAs can always go into a 401(k). 

How long can you keep an old 401k?

Generally, there is no time limit if you have a balance over the required minimum amount.

Mile High Finance Guy

finance demystified, one mountain at a time

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