Leaving a job is a big deal, and it comes with a lot of important decisions—one of the most significant being what to do with your 401k. Should you roll it over to a new plan, or should you just leave it where it is? In this post, we’ll break down your options so you can make the best decision for your financial future. Make sure you read until the end, where I’ll share a little-known rule that could make your decision a bit easier!
Understanding Your Options
When you leave a job, you have several choices for your 401k:
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Leave It with Your Former Employer:
This might be the easiest option, especially if you’re satisfied with the investment choices and the fees are reasonable. 401k plans often have strong creditor protection and might offer lower-cost institutional funds. However, there are downsides too—you might have limited investment choices, and it’s easy to forget about an account that you’re not actively managing. Plus, you have less control over the funds since the employer’s plan rules still apply. -
Roll It Over to Your New Employer’s Plan:
Rolling your 401k over to your new employer’s plan can be a good way to keep all your retirement savings in one place, making it easier to manage. If your new employer’s plan offers similar or better investment options, this could be a smart move. But be cautious—new plans might have higher fees or more limited choices. Review the new plan’s options carefully before making the switch. -
Roll It Over to an IRA:
Rolling your 401k into an IRA gives you greater control over your investments and a wider range of options to choose from. An IRA might also offer lower fees, depending on the provider you select. However, be aware that rolling over to an IRA can mean losing some of the creditor protections you’d get with a 401k. It’s also important to handle the rollover correctly to avoid any penalties. -
Cash It Out:
While cashing out might seem tempting—especially if you’re in a financial bind—it’s usually the worst option. Cashing out your 401k can result in significant tax penalties, and you’ll miss out on the potential growth that money could have if it stayed invested.
Evaluating Fees and Investment Options
Let’s talk about fees and investment options because they can significantly impact your decision.
401k plans typically offer low-cost institutional funds, which can be a huge advantage. But not all plans are created equal. Some 401k plans charge higher administrative fees, which can eat into your returns over time. On the other hand, rolling your 401k into an IRA usually gives you access to a broader range of investments, including stocks, bonds, mutual funds, and ETFs. However, IRA fees can vary widely depending on the provider.
So, what should you do? Take a close look at the specific fees associated with each option. Ask yourself: Are there low-cost index funds available? What are the administrative costs? Understanding these factors will help you make a more informed decision.
Understanding Tax Implications
Tax implications are another critical factor to consider.
If you decide to roll over your 401k, the good news is that it’s generally tax-free if you do it the right way. You’ll want to do a direct rollover, where the money goes straight from your old 401k plan to your new one or to an IRA. If you do an indirect rollover, where the money is sent to you first, you could face withholding taxes and potential penalties if you don’t deposit it into a new retirement account within 60 days.
Now, if you’re thinking about cashing out your 401k, be prepared for some serious tax consequences. Not only will you owe income taxes on the full amount, but if you’re under 59½, you’ll also get hit with a 10% early withdrawal penalty. That’s a hefty price to pay and is usually not worth it.
Aligning Your Decision with Long-Term Goals
Finally, let’s talk about aligning your decision with your long-term strategy and goals.
Your retirement timeline is a big factor. If you’re planning to retire soon, you’ll want to ensure your 401k or IRA is set up to support that timeline. This includes having the right investment options that provide the growth or income you need.
Risk tolerance is another key factor. If you roll over your 401k to an IRA, you might have access to a wider range of investments that better match your risk profile. This could be particularly important if you’re either very conservative or very aggressive with your investments.
Now, let’s talk about income distributions. Some 401k plans have restrictions that can make accessing your funds more challenging, especially if you plan to take periodic distributions in the near future. On the other hand, an IRA typically offers more flexibility regarding withdrawals, which could make it a better option if you’re planning to tap into your portfolio regularly.
And here’s a tip that many people overlook: It’s called the Rule of 55, and it allows you to take early 401k withdrawals without a penalty. If you leave your job during or after the year you turn 55, you can start taking withdrawals from your 401k without incurring the 10% early withdrawal penalty. This can be a game-changer if you’re planning to retire early. However, it’s important to note that this rule only applies to your current employer’s 401k. If you roll your 401k over to an IRA, you lose this option. That’s why it’s essential to carefully consider your choices before making a move.
But if you’re interested in the Rule of 55 and previously rolled an old 401k into an IRA, you still have options—provided you have a current job with an existing 401k. Some plans might allow you to roll that IRA into your current 401k, enabling you to apply the Rule of 55 to these funds as well. However, it depends on the specific rules of the 401k plan. Not all plans offer this option, so it’s crucial to check with your employer’s plan administrator to see if this is possible. Doing so can streamline your retirement accounts and even offer some strategic advantages when it comes to Roth conversions—but that’s a topic for another day.
Conclusion
Deciding whether to roll over your 401k or leave it in your employer’s plan is a significant decision that can have lasting effects on your financial future. You’ve got to weigh the options carefully—considering fees, investment choices, tax implications, and how it all fits into your long-term goals.
Remember, the choice you make today can significantly impact your financial future. Take the time to evaluate your options and make the decision that’s right for you.
If you’re unsure about what to do with your 401k or need help aligning this decision with your overall financial plan—I’m here to help. Visit our website at thehourlyadvisor.com to schedule a free consultation. Let’s ensure your retirement savings are working as hard as you are!