With the average person changing jobs between 10 and 15 times throughout their career, deciding what to do with your old 401(k) after you quit one job for another can be a tough decision. The right answer for you really depends on your situation. We’ll go through the different options available and highlight some key points to consider before you make your decision.
When you do decide to leave your job, you generally have 4 options with your 401(k) money.
- Leave the money in the old 401(k) plan
- Cash in the old 401(k)
- Rollover the old 401(k) to the new company 401(k)
- Rollover the old 401(k) to an IRA with or without an investment adviser
The first consideration you should make before even leaving a job (if possible) is the vested balance of your 401(k). Your vested balance is the amount of money in your 401(k) that is yours to keep if you left your employer today. The contributions you make personally to your account are always immediately vested. However, contributions that your employer makes may be only partially vested. That money is usually partially vested until you have been employed long enough to be fully vested. So you’ll want to know your vested balance and any important dates. (You’d hate to quit right before you became vested, if at all possible)
Leave the Money in the Old 401(k) Plan
When you leave your current employer you can also leave behind your 401(k). As long as you meet the minimum account standards for your particular plan (usually around $5,000) you don’t have to do anything. You still get the benefit of tax-deferred growth on your investments. The problem with this option is that many take an “out-of-sight, out-of mind” approach and tend to forget about the investments in their old 401(k) plans. You won’t get much support with financial planning or making investment decisions and your investment options are also limited to those in the 401(k) and can be changed by the plan sponsor without your consent.
Cash in the Old 401(k) Plan
Another option that sounds enticing yet is the absolute worst, is to cash the 401(k) in. “Cash me outside?” How ’bout no! This is bad for a number of reasons. First, every dollar you cash in is subject to your current income tax rate. Besides that, if you are under the age of 59 1/2 there is a 10% penalty you will also pay. Not only do you lose a huge portion of your savings to taxes, but you lose the ability for future, tax-deferred growth. And finally, cash that is easy to spend is less likely to be saved for your future retirement needs, so the probability of your success in retirement is also going down.
Rollover the old 401(k) to the new company 401(k)
A third option is to move the money into the new 401(k) plan. This option is better than the first two because you get to continue to benefit from tax-deferred growth and you also will be more likely to stay up to date on what the account is doing with your current employer.
However, there are a number of possible downfalls when it comes to 401(k) plans concerning fees, investment selection and service/help.
When it comes to fees in a 401(k) retirement plan, they are just now starting to become clear. The Department of Labor recently passed new regulations in 2012 requiring plan administrators to begin notifying the plan participants of the fees associated in being a part of the plan. That said, there are a number of fees to be aware of in a 401(k) plan. The first are administrative expense fees, which are for things like legal, accounting and record keeping services. The actual investments, such as mutual funds, within a 401(k) also have fees that are usually expressed as a percentage term on an annual basis. If the 401(k) plan has a broker there may be commissions, as well as ongoing 12b-1 fees from the sale of new investment products. Finally, there may be trading costs incurred when switching from one investment to another. All of these fees vary depending on the size of the plan as well as company so you’ll want to consult your Plan Description document to make sure you know exactly what you’re paying.
When it comes to the investments available in a 401(k) retirement plan, the options are usually pretty limited. In many cases, participants in the plan are given a list about a dozen mutual funds that the plan sponsor has determined will be available. This limits the control that you as an individual have on your investments. Some 401(k) plans will have “brokerage windows” that allows access to a greater variety of investments, however you are left to do your own research as to which investments are the best for your situation.
Service & Help
The individual support you receive from a 401(k) plan is usually pretty low. For 401(k) plans administered by larger companies, the telephone may be the only contact available to discuss your options. There also may be a broker associated with the plan but with one broker to many participants it can be difficult to get any attention.
Rollover the old 401(k) to an IRA with or without an Investment Adviser
Rolling over the 401(k) to an IRA with an Investment Adviser is a popular choice for many reasons. They include transparency of fees, virtually unlimited investment options, and personalized service.
There are a number of fees to know about in an IRA account with an investment adviser. The first is an asset management fee. If you are working with an fee-only investment adviser, they charge a fee for the management of your investments. This fee is expressed as a percentage of the money in the account on an annual basis. Most investment advisors charge around 1% annually. The actual investments in the account also may have a fee. For example, ETFs and mutual funds have fees also expressed as a percentage charged annually. For most ETFs, the fee ranges between .09%-.7% while mutual funds fees range between .2%-2%, with the average between 1.3%-1.5%. Finally, the cost of buying and selling an investment within the account also has a cost, which is typically between $7-$20 per trade. *NOTE If you are working with a broker (salesperson) they will be compensated from a commission for the sale of an investment instead of a asset-based fee. This commission is usually between 3-5% of the amount invested. Make sure you know the type of professional you’re working with beforehand!
One distinct advantage to an IRA account is the freedom to invest your money in a nearly unlimited number of investment options. Stocks, bonds, ETFs, mutual funds, currencies, real estate, alternative investments, etc are the choices you have. This allows you to remain in complete control because you are not confined to a list of mutual funds your company has chosen for you. It also allows you to be flexible with your investment strategy and stay broadly diversified.
Service & Help
By rolling your 401(k) to an IRA with an investment adviser, you have more support and service than in a 401(k) plan. Typically you will develop a financial plan that will outline your current financial status as well as financial goals. This in-person, personalized service can help clear up the questions you have regarding your retirement and be a lot more helpful. Also, investment advisers act as a fiduciary, meaning they are required by law to do what is in your best interest. And because they are compensated based on the percentage of assets, they will have the same interests as you in maintaining and growing your account.
In the end, it is your decision which retirement account and rollover option suites your individual needs. However, after looking at the advantages and disadvantages of all options it is clear that the virtually unlimited investment options, transparency of fees, and opportunity to work face to face with an investment adviser makes rolling your 401(k) to an IRA when you switch jobs an attractive option.
Have an old 401(k) you have questions about?
If you’ve recently switched jobs or have a 401k from an old job and are wondering which option is best for you, I make getting answers super easy, without having to talk to some high-pressure sales person. Just ask a question via our secure, confidential contact form and I’ll get back to you vial email within 48 hours to help point you in the right direction.
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