U.S. workers change jobs about once every 5 years on average. Consequently, with the increasing number of companies offering 401(k) plans, the average worker is frequently faced with the decision of what to do with the old 401(k) when he or she takes a new job. The important thing to remember if you find yourself in the position of changing careers is you’ve got options — and some are better than others. Here are the top four options and insight into whether or not they’re a good fit for you.
Option One: Leave Your Old 401(k) with the Previous Employer’s Plan
Generally speaking, we’re not a big fan of this choice. It’s certainly the easiest option, but it can leave you with less in the end. If you decide to go this route you need to stay engaged with your investments even after cutting ties with your employer — a difficult thing to do for multiple reasons. You’ll want to keep up with several things if you choose to do this:
- Your 401(k) investment objectives, which can change over time
- Fees charged to the account
- Fees charged through your investment fund
In some cases the fee charged to the company plan, which is generally covered by the employer, can get transferred to your individual account in the plan after you leave the company. This additional layer of fees could put a huge cramp on future growth.
The takeaway: The only time we advise leaving your 401(k) with the previous employer is when the previous plan has better investment choices along with lower fees. Individuals can have a hard time distinguishing this due to the complicated nature of fees, so it’s worth having your financial advisor look at your options.
Option Two: Move Your Old 401(k) to Your New Employer’s Plan
Taking your money with you to your next employer is a good choice as long as investment choices and fees are comparable. It’s a no brainer if you can get into funds in your new plan that cost less. This move also allows you to keep tabs on all of your investments so you can quickly change them as your objectives do too. This decision could simply boil down to who you feel more comfortable interacting with about your 401(k), your current or previous employer.
The takeaway: Generally speaking, this option rarely a bad idea. You’ll get the benefit of having your funds all in one place, and you’ll probably be a higher priority with your new company than your old one. Just make sure that your investment options and fees seem reasonable. Otherwise, the next option on this list will be your best choice.
Option Three: Move Your Old 401(k) to an IRA
The process of moving your 401(k), or rolling it over, to an IRA gives you a little more control than the previous two options. When you roll your funds into an IRA, you’ll most likely hire someone outside of your employer to manage your account. Depending on fees and investment objectives, this can be a great solution. No doubt you’ll have access more investment choices and information going this route, which could lead to a much more individualized investment solution compared to the one-size-fits-all investment choices of 401(k) plans.
The takeaway: This option will be your best choice if you’re looking for a higher level of service and a personalized investment portfolio solution.
Option Four: Taking the Lump Sum
Cashing in an old 401(k) is generally not advisable before retirement. Although there are some special cases where it could be the right choice for you, more times than not it isn’t. Since most 401(k)s contain pre-tax contributions, you defer tax payment until distribution. If you collect the distributions before age 59 ½ you’ll pay federal and state taxes (where applicable) with an additional 10% early distribution penalty. Depending on where you live and the tax bracket you fall into, that could be up to half of your account going to taxes and penalties. Not to mention the enormous pressure you put on your long term financial plan by eliminating previous savings.
The takeaway: This option should be a last resort reserved only for extreme financial situations.
As always, each financial situation is unique, so if you’d like to talk over your situation contact us here and we be glad to help.
Photo courtesy of visitBerlin
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