When I was leaving my job, I had more than a few questions running through my head. Like: “What the heck am I going to do about insurance?” “How do I cash out my vacation days?” And of course, “What should I do with my 401(k)?”
Oh right, yeah. That 401(k) plan, a.k.a. “That retirement thing I opened up when I first started working here and now I have no clue what to do with it.”
I get a lot of reader questions about retirement plans. Why? I think it’s because deciding what the heck to do with your old 401(k) when you leave your job is one of the most confusing financial decisions you have to make in your 20’s and 30’s.
So if you’re reading this, chances are you’re in the same boat as I was. You might be:
- Changing jobs to a new employer with a different 401(k)
- Changing jobs to a new employer that doesn’t offer a 401(k)
- Becoming self-employed (yeah, damn the man!)
- Becoming unemployed (ah, damn the man!)
Whatever the case, you’ve got a lot of options to consider – and what you choose to do with your 401(k) could mean the difference between retiring with millions or pennies to your name.
so just what should I do with my 401(k)?
At the time, deciding what to do with my old 401(k) was messy and confusing. I really wish I’d had a guide with all of my options laid out in plain English. A big decision like this deserves a simple and detailed explanation.
So that’s what I’ve put together: the one-stop shop for all your 401(k) questions… with a cartoon dog to guide you along the way 🙂
Introducing: the 401kanine: the smartest glasses-wearing, necktie-sporting, coffee-drinking office dog I know. And he’s here to explain all your 401(k) options with cartoons.
He’ll give you the scoop on your three basic options for hand;ing your old 401(k): cashing out, staying put and rolling over. We’ll walk through each option one at a time, but be sure to check out the full infographic at the bottom of the post for the whole picture!
What exactly are my 401(k) options?
So you’ve got three major options when it comes to your old 401(k) – some better than others. We’ll walk through each of them below:
Option 1: Cash Out Your 401(k)? No, NO! Bad Dog!
Cashing out your 401(k) is an easy temptations… and possibly one of the worst decisions you could make for your financial future. This is money for retirement, so taking out money before you’re retiring means you’ll literally have to pay for it.
If you withdraw money from your 401(k) plan before you’re 59 ½ years old:
- You’ll pay a 10 percent early withdrawal penalty.
- You’ll pay income tax today on your pre-tax contributions, your earnings on any post-tax contributions and any employer contributions (i.e. the IRS gets a nice slice of your account balance before you see that money).
- You’ll be losing out on the chance to keep growing your retirement money.
So if you thought cashing out meant you’d be getting all that retirement money to do with whatever you want to do, think again. After taxes and an early withdrawal penalty, that 401(k) balance gets cut down quickly.
Here’s how the math shakes out:
Let’s say you’ve got a $10,000 401(k) balance you want to cash out.
- When you withdraw the money, 20 percent of that automatically goes to the IRS for federal taxes (you get a check for $8,000, and $2,000 goes to taxes)
- When you file taxes the next year, you’ll owe the 10 percent penalty on your original balance and you’ll have to pay this out of pocket (that’s another loss of $1,000)
- What was a $10,000 balance turns into a net of $7,000 really quickly!
But here’s why cashing out your 401(k) doubly sucks: not only are you losing out on money today (taxes and fees) but you’re also possibly losing out on money tomorrow because your money’s not invested. Sure, there’s no guarantee you’ll get a return by investing in the stock market, but it’s safe to say that cashing out your 401(k) means you’re not giving your money a chance to grow.
Bottom line: if you want to keep growing your money and you don’t want to lose it to fees, don’t cash out.
OPTION 2: Sit, stay! (leave your 401(k) where it is)
Another option? Just leave your money in your old 401(k) plan, even if you’re not going to be working for that employer anymore. There are two reasons why you might consider keeping your old 401(k) where it is:
- You don’t have a better option lined up yet. If you haven’t enrolled in the 401(k) at your new employer or opened an IRA, don’t worry about your old 401(k) quite yet. The last thing you need if you’re leaving a job is to stress over about moving your 401(k) ASAP. Just don’t forget about it when you leave your job! You’ll keep getting quarterly statements from your old plan, but you’ll probably want to start thinking about where you want that money to end up.
- You’re happy with the investment options offered in your old 401(k) plan. Your 401(k) plan is controlled by your employer, which means they choose the type of investments you have access to. If you’re happy with your options at your old employer, then leaving your money with them might make sense (at least for now).
But hold up a moment: even if you do want to stay in your old employer’s 401(k) plan, you might not even be allowed to keep it there if your balance is less than $5,000. And even if you are allowed to keep your funds where they are, some 401(k) plans charge higher fees to ex-employees.
Bottom line: leave your 401(k) alone if you’re not ready for the next step yet, but create a plan for when and how you want to move your money.
If you are ready to move your money where it can do the most good, you may want to consider Option 3.
Option 3: Rollover!
Ready to keep that retirement ball rolling? Rolling over your old 401(k) funds into another retirement plan is a great way to make that happen. With a direct rollover, your funds are sent straight from your old 401(k) into an IRA or a new 401(k) without any penalties.
So if you’re ready for the rollover, here are the two basic options:
1. Rollover into a new 401(k): If your new employer offers a 401(k) and you want to manage your retirement money all in one place, this is a great place to rollover your old 401(k). Just keep in mind that not all employers accept rollovers from your former employer’s plan, so check with your new plan administrator to see what’s possible.
2. Rollover into an IRA (Individual Retirement Account): If you don’t have access to a 401(k) at your next job (or you’re becoming self-employed or unemployed), you might consider rolling over your old 401(k) balance into an IRA (individual retirement account). It’s like a 401(k) but on your own, since there’s no employer sponsoring the plan. With an IRA, you’ll likely have a wider variety of investment options than a 401(k). Just make sure you keep your account fees low by using a discount broker or online, automated account manager.
Wherever you decide to move your money, try to keep things as simple as possible. How?
- Rollover into similar accounts: If you’ve got a traditional 401(k), it’ll be easier to roll it over into a traditional 401(k) or IRA. That means avoiding a transfer into a Roth account. If you transfer pre-tax retirement money (like 401(k) contributions) into an account that’s taxed in a different way (like a Roth 401(k) or Roth IRA), you’ll have to deal with complicated, messy and expensive out-of-pocket tax payments. Keep it simple and stick with an apples-to-apples rollovers.
- Don’t get a check: If you can avoid it, don’t get a direct check from your 401(k) plan administrator. Getting a check for the amount of your old 401(k) balance makes things infinitely more complicated. Once you receive a check, you’ll have 60 days to get that money into a new retirement account before you get hit with any early withdrawal penalties. If your plan administrator has to cut you a check, be aware of any deadlines and deposit that money into a new retirement account ASAP.
Bottom line: roll over your 401(k) balance into a new 401(k) or IRA if you want to manage your money all in one place. Keep things simple with a direct transfer into a similarly taxed account and look for low-cost account options.
Teach me how to rollover!
With me so far? Ready to rollover? Here are the steps to you’ll need to take to move that old 401(k):
- Pick the destination for your money. Your first job is to pick the account for your 401(k) rollover. If you’re not rolling over into a new employer’s 401(k) plan, you’ll want to start researching your IRA options and look for an affordable brokerage company where you can open up an individual account (I’ve got a recommendation below). There are plenty of discount brokerage firms that will allow your funds to grow without too much of your money going toward extra costs. Remember: the company that’s getting your rollover funds is making money off of you, so pay close attention to any fees they may charge.
- Open your new account. Once you decide where you want your retirement funds to go, you’ll either 1) fill out paperwork with your HR representative at your new job to open up your new 401(k), or 2) open an account with a brokerage firm to start your IRA.
- Request your distribution paperwork for your old 401(k) plan. This is where lots of people get tripped up: to get your 401(k) funds moved over, you’ll need to talk to your HR representative at your old job. You can also reach out directly to your old 401(k) plan administrator and ask them what you need to do to rollover the funds into a new account.
- Begin the rollover process. The actual rollover process varies from plan to plan and company to company, so it’s worth talking to your old HR rep or old plan administrator and your new 401(k) plan administrator so you know exactly what you have to do, what papers you have to sign, and how long it might take. Remember, your HR rep and your plan administrator get requests like this a lot, so ask as many questions as you want!
- Be patient! The rollover process can be a lot of paperwork and take up a lot of time. Don’t worry if your funds take a while to transfer over to your new retirement account; at the same time, don’t be afraid to follow up with your old 401(k) plan administrator if things start to stall.
One EasY Option for Where To Rollover Your 401k?
Okay, phew! That was a lot. And if you’re still with me, hopefully you’ve got a better sense of what you want to do with your money and how to do it. But if you’re like me and you’re looking at the IRA option, I had a really tough time deciding where to go. And I kinda wish I had gone with an easy-to-use, online investing service like Betterment.
I just started using Betterment for my regular, non-retirement investing, and I love it. It’s one of the slickest, easiest online platforms for managing my investments. And they now you can use them to roll your 401(k) over into an IRA! Here’s why they’re such a simple, low-cost option:
- Fast and no paperwork. Betterment doesn’t require any forms or paperwork to open a rollover IRA.
- Low cost. It’s free to set up a rollover IRA (there might be some charges when you close your 401k). Betterment doesn’t charge trading fees, and their investing costs are some of the lowest in the industry.
- Hands-on customer service. The process seems really simple, but you can always talk to a real person to sort out any problems.
I love Betterment so much for my regular investing that I’m looking at rolling over my IRA over there. Check ’em out, and let me know what you think. If they’re half as good helping you manage rollovers as they are with helping you manage regular investments, then they’re awesome.
Have any more questions about your 401(k)? Let me know in the comments below. Remember, I’m not a licensed investment adviser and this post is for informational purposes only (not investment advice), but I did ask my Certified Financial Planner friends to weigh in and help with this post.
Hopefully the 401kanine has at least given you a step in the right direction!
Thought the 401kanine was a good way to explain your 401(k) options? I’ve packaged it all together in a neat 401(k) infographic below. Please share it if you think it’s helpful and feel free to embed it into your own website! (The code’s below)
Download this infographic.
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