In most cases when you leave a job you should roll over your 401(k) into an IRA. One of the main reasons to do this is the flexibility of investment options (and potential lower cost ratios). There are some instances (in the minority) when you shouldn’t perform this rollover and your financial advisor is best equipped to help you make this decision. Here’s an article about rollovers that discusses some of the pros and cons:
Roll over or not? Smart 401(k) moves when you quit your job
Jeff Reeves, Special for USA TODAY 11:02 a.m. EDT March 25, 2016
In 2016, the U.S. labor market remains strong across many measures. That includes the number of employees voluntarily leaving their current jobs in pursuit of greener pastures.
According to December data from Bureau of Labor Statistics, the rate of “quits” has at last surpassed pre-recession readings from the end of 2007 — hinting that qualified workers have more job options than in roughly a decade.
But while a new job can be full of exciting opportunities (and hopefully a bigger paycheck) there is also uncertainty that comes with such a change. And for many, that includes uncertainty over what happens to their previous employer’s 401(k) plan.
First things first: While there are several options for what to do with an old 401(k), you should remember that the money is still all yours, said Andrew Meadows, a vice president at online benefits provider Ubiquity Retirement and Savings. And if you have more than $5,000 in your account, it can stay where it is as long as you like.
“Just because you’ve left an employer, you don’t have to move it,” Meadows said.
The only catch is if you have a balance of less than $5,000. In these cases, it is legal for employers to force you out of their 401(k) either by cutting you a check or automatically rolling your funds over into a third-party IRA, depending on their policy.
Of course, there are drawbacks to simply leaving your cash where it is.
“You may be charged higher fees as a former employee,” said Ken Moraif, a certified financial planner at investment advisory firm Money Matters in Dallas. Also, you don’t have a benefits representative down the hall anymore to explain changes in investment options that might take place over the coming years.
So, if you do choose to stay put, Moraif said, “It is important that you know the rules.”
Rolling over your 401(k) to an IRA
If you’d prefer to part ways with your old 401(k) plan, however, there can be big benefits to rolling over those funds into an individual retirement account.
Moraif notes that rolling over your cash from a 401(k) to an IRA can unlock a host of new investment options instead of just the five or 10 mutual funds your employer offered.
“You have almost unlimited choice, maximum control and flexibility,” he said.
Also, if this isn’t the first mothballed 401(k) from a previous employer, wrapping your arms around your retirement outlook can be a challenge, said Kimberly Foss, a certified financial planner and president of Empyrion Wealth Management in Roseville, Calif.
“If you change jobs multiple times over your lifetime, you may end up with numerous 401(k) plans, which can be confusing when evaluating your entire investment plan and reviewing performance statements,” Foss said. “Holding all of your retirement funds within one IRA may make monitoring your investment strategy much simpler.”
Foss is quick to point out, however, that anyone rolling over a 401(k) to an IRA should do so via a “direct rollover” from one financial institution to another, and avoid touching any of the money as it is transferred. That’s because if you take possession of these tax-sheltered retirement funds and don’t follow IRS guidelines to the letter, the money may be seen as an early withdrawal instead of a rollover.
And that can result in steep penalties.
“You’ll not only lose a significant portion of your funds to income taxes, but you will also be required to pay a 10% penalty for early withdrawal — and you would lose out on the opportunity for future tax-deferred growth,” Foss said.
In fact, those costs are one of the big reasons why few financial advisers ever recommend taking a cash distribution from an old 401(k) if you move on to a new job.
It’s also worth remembering the lost growth potential and retirement security in addition to any penalties, Foss notes. After all, the purpose of saving in a 401(k) to begin with is to provide for your golden years, and taking a cash distribution now is reducing both your nest egg and your future investment returns over the next few decades.
“Just $25,000 held in an IRA for 30 years, even at a conservative rate, can make a huge difference in your lifestyle when you retire,” she said.
Jeff Reeves is executive editor of InvestorPlace.com.