If you’ve left a job, then there is a question you probably have: what do I do with my old 401(k)?
In this article, we lay out the options you have. There are 7 things to do with your old 401(k), although how many apply to you will be dependent upon your particular circumstances. If in doubt, call your financial advisor, or contact us if you prefer.
1 – Cash it out
Depending on your age and tax bracket, this might be the worst thing you can do. Here’s why.
First, if you are under 59 1/2, you’ll pay regular income taxes on the amount you cashed out.
Second, you’ll pay a 10% penalty on top of it (unless you’re over 59 1/2). If you are in the top tax bracket cashing out a $100,000 401(k), you would see $47,000 of your money disappear – $37,000 in taxes plus $10,000 in penalties.
Caveat: There is an exception to get out of the penalty, known as the "hardship rule." The IRS covers this in good detail on a web page titled "Hardships, Early Withdrawals and Loans", Definitely speak with a financial planner and CPA to make sure before you do this.
If you are 55 or older, and are no longer working, then the penalty may not apply, but talk with your accountant to be sure before cashing out just to make sure.
2 – Partial cash out
Not all 401(k) plans offer this options, and if they do, the rules in #1 still apply. For that reason, we recommend against this except in case of either retirement or a true financial emergency.
If you are over 70 1/2, you will have to take Required Minimum Distributions (frequently referred to as “RMDs”) based on your age. People usually choose this option for that reason.
3 – Leave it there
There are times where this option makes sense, such as when other life events are occurring that limit your ability to make changes. In general, leaving your funds in the old plan tends to be a bad idea for a few reasons:
- If you leave it there, it may be hard to get access to your account in the future. We’ve seen this happen multiple times, often with frustrating paperwork that you will end up doing. Moving to a new address and marriage are the biggest problems with an old 401(k).
- Your beneficiaries are not updated. If you get divorced, widowed, remarried, have children, etc., your beneficiaries should be updated. Old accounts tend to be forgotten in this process.
If you die in this situation, the beneficiaries will inherit your old 401(k) as you had listed them regardless of what your will states.
If you forget about the account for several years, don’t be surprised if this process takes a few months as well as signed affidavits to roll it into an IRA or current 401(k).
4 – Roll it into your new 401(k)
Instructions vary considerably depending on how each of the 401(k) plans are managed. This is our second-best recommendation for handling your old one. There can be considerable paperwork involved on both sides. The old 401(k) may transfer the funds electronically, or may mail a check to you instead. If they send you a check, do not cash it. Your new 401(k) plan will give you specific instructions to follow.
There is one situation where this might be the best option – if you are subject to Required Minimum Distributions (RMDs). In that case, you are exempted from having to take RMDs from the plan with your current employer until you retire (see more at the IRS page on Required Minimum Distributions ).
Caveat: Your new 401(k) plan may not allow old plans to be rolled into it. Check with either the HR department at your new firm, or contact your new 401(k) provider.
5 – Roll it into a Rollover IRA
We recommend this options for two reasons. First, you will have more investment options in a rollover IRA. Second, this will help consolidate your assets.
When you roll over your 401(k) to an IRA, make sure you do it as a “custodian to custodian” transfer, and do not cash the check (otherwise you could incur taxes).
This process can be done in a single phone call in most cases. See our article for instructions on how to properly roll over a 401(k).
6 – Roll it into a Roth IRA
For those of you that have made contributions to a Roth 401(k) or made after-tax contributions to your regular 401(k), you will need to roll those funds into a Roth IRA instead of a Rollover IRA.
Caveat: Make sure you only have Roth 401(k) contributions before starting this process. It is easy to have both Roth and regular contributions. A likely scenario is where you have employer matching contributions, where the employer match must be to the regular (pre-tax) part of the 401(k) plan by law.
Again, as in number 6, make sure you do it as a “custodian to custodian” transfer, and do not cash the check (otherwise you could incur taxes). See our article for instructions on how to properly roll over a 401(k).
7 – Roll it into both a Rollover IRA and a Roth IRA
If contributions were made to both the regular and Roth portions of a 401(k) plan, the rollover process will be more complicated, but basically it will be a combination of steps 5 and 6, with the caveat that you make extra sure to have two checks cut – one for the Roth component, and one for the regular component of the 401(k).
By having two different checks, you minimize the chance of paperwork error during the process. Further, you gain the ability to validate that the amounts for each is correct. Making a mistake here will cost you money down the road – either in gains lost to redundant taxes, or a penalty if misconstrued.
For instance, if you contributed to a Roth 401(k), and the company contributed a similar matching amount, then you know you should be getting 2 checks that are roughly equal to each other.
Other stuff
Since every administrator is different, and not all plans are alike, we can’t go into all the specific paperwork details for each plan. However, this guide should help you work through most situations, and be able to get the specific paperwork from your particular plan administrator.
There are some things that we have not covered, such as
- Plan administrators that require a spousal consent form (which requires your spouse’s approval to move the funds to another account); This is usually pretty simple, but if necessary, is an extra piece of paperwork you need.
- Plan administrators that require a Medallion Signature Guarantee (which you will need to get from your new custodian). This is basically a guarantee that the new custodian provides that if fraud is involved in the transfer process, that they are liable for the funds, not the original plan administrator. Don’t confuse this with a Notary stamp, as that can only be provided by the receiving custodian (so don’t ask a notary for it, because you will just have to go do it again, anyway).
- Plans that are either rolled over to an annuity or contain an annuity. The complexity of either of these situations requires individual attention, as they can be different not only for each plan, but also for each participant within a plan.
Final note
A good advisor will walk you though these options, and guide you through the process. In effect, a rolloever should be easy with a good advisor. If they make you do everything yourself, it might be good to find a more helpful advisor
Caution: If someone has convinced you to roll over your plan to an annuity, we strongly recommend that you get a second opinion from an unbiased advisor. There are many reasons *not* to do this, but those reasons are often not discussed or hand-waved away as trivial by the person selling you the annuity. And remember, the commission check to the person selling you the annuity can be 10% of the total value of your 401(k) !