Where to Rollover Your 401(k) Retirement Money
Stumped by what to do with your old workplace retirement account? Money Girl helps you find the best place to move your 401(k) to avoid tax and keep your retirement nest egg growing.
Laura Adams, MBA
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Where to Rollover Your 401(k) Retirement Money
Congratulations- you just accepted a new job! But now, what should you do with your workplace 401(k)? This is a common question that stumps many workers.
In this episode I’ll discuss options for what to do with an old 401(k), no matter why you may be moving on from your job. You’ll learn the best ways to avoid taxes and penalties, and keep your retirement nest egg growing.
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What Is a Retirement Rollover?
While a rollover sounds like a cute trick you might teach your dog, it means something completely different in the world of personal finance. When it comes to your money, doing a rollover means moving funds from one retirement plan to another.
If you’re like most workers, you’ll change jobs several times over the course of your career. The beauty of a workplace retirement plan, such as a 401(k) or a 403(b), is that it’s portable. In other words, you own it and can always take the money with you when you leave a job.
When you rollover a retirement account, you don’t lose contributions you’ve made or the investment earnings that may have accumulated over time. And if you’re vested, you don’t lose money any money that your employer contributed as matching funds or discretionary profit sharing.
Rolling over money from one retirement account to another means you don’t have to pay any tax. The funds maintain their tax-deferred status until you make withdrawals in the future.
The only trick with a retirement rollover is that once you initiate it, you must complete it within 60 days. Otherwise, it’s considered an early withdrawal. If you’re younger than age 59½, taking an early withdrawal triggers income tax, plus an additional 10% penalty.
Also see: Should I Count Matching Funds in My Retirement Plan?
Options for an Old 401(k) Retirement Account
When you switch jobs, you typically have the following 4 options for your workplace retirement account:
1. Cash out the account.
2. Leave the funds in your old employer’s plan.
3. Rollover funds into a new employer’s plan.
4. Rollover funds into an Individual Retirement Arrangement (IRA).
Cashing out a retirement plan when you leave a job is the easiest, but worst, option.
Option #1: Cash Out
Cashing out a retirement plan when you leave a job is the easiest, but worst, option. As I previously mentioned, taking an early distribution means you get hit with both income tax and a 10% penalty! Here’s what could happen:
Let’s say you have a balance in the account of $100,000 and decide to cash out. If you must pay 40% for federal and state tax, plus an additional 10% penalty, you lose 50%. Your $100,000 nest egg just shrunk to $50,000 in one fell swoop.
To find out how much cashing out early could damage your future retirement savings, use an online tool like Bankrate’s 401(k) Spend It or Save It? Calculator.
Option #2: Leave the Funds
If you have enough money in your old 401(k) or 403(b) retirement plan to satisfy the minimum account balance, which is usually $5,000, then you can leave your money there.
The downside is that you can’t make any new contributions to the account. Plus, you may be less likely to keep up with it after you no longer work for the company.
However, you have the same access to the account and can manage it any way you like by selling and buying funds from the available menu of investment options. An old workplace retirement plan can continue to grow on a tax-deferred basis, which means you don’t pay tax until you make withdrawals from the account in the future.
If a former employer’s plan has a menu of diversified investments with low fees, leaving your money there may be a good idea. And you can always do a rollover in the future. Just make sure that the plan doesn’t charge higher fees if you’re not an active employee.
Option #3: Rollover Funds Into a New Employer Plan
If your new employer offers a retirement plan, you may be able to rollover funds from your old plan once you’re eligible to participate. But in some cases, incoming 401(k) or 403(b) rollovers aren’t allowed, so be sure to check the plan’s rules or ask your new benefits administrator.
The downside to transferring funds from one workplace retirement plan into another is that you can’t take the money out until you leave the new company.
One upside to consolidating workplace plans is that having all your retirement savings in one place may make it easier to track. Just make sure that the new plan has a wide selection of investment choices with low fees.
Another important consideration is the legal protection that your money has while it’s in a 401(k). The Employee Retirement Income Security Act of 1974 (ERISA) doesn’t allow creditors, except the federal government, to touch money in a qualified workplace plan.
In other words, if you get into financial trouble because you can’t pay your mortgage, the lender could sue you, but wouldn’t be able to take your 401(k) money to repay your debt. That may not be the case for money in an IRA, which I’ll cover next.
Option #4: Rollover Funds Into an IRA
The final option for your old retirement plan funds is to do a rollover into a new or existing IRA. An IRA is a retirement account that you own as an individual.
Even though it’s different than a 401(k), doing a rollover to an IRA within 60 days doesn’t trigger income tax or a penalty. Your new earnings in the account will grow tax-deferred, just like they did in your old workplace plan.
Having money in an IRA gives you the most flexibility and control because you choose the financial institution and your investments. You’ll have a full range of options—such as stocks, bonds, and exchange-traded funds—that are typically not included on the investment menu for a 401(k).
Additionally, unlike with a workplace retirement account, there are situations when you can take money out of an IRA, before reaching age 59½, and avoid the expensive 10% penalty. Some exceptions include using IRA funds for medical expenses, college costs, and buying or building your first home. Just remember that you’ll still have to pay ordinary income tax on those withdrawals.
The major downside to rolling over an old retirement plan into an IRA is that depending on the state where you live, IRA assets may not be protected from creditors through ERISA, the law that I previously mentioned.
Whether creditors can touch some of all of your retirement money in an IRA varies from state to state. So, if protecting your retirement from creditors is a concern for you, be sure to ask your existing or potential new IRA custodian about your state’s regulations.
Also see: How to Open a Rollover IRA (with video)
The Best Place to Rollover Your 401(k) Retirement Money
To sum up, the best place for your old 401(k) will depend on the flexibility and legal protections you want, the quality of your old plan, and whether you have a new retirement plan that accepts rollovers.
The goal is to position your retirement money where you can keep it safe and allow it to grow using low-cost, diversified investment options.
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.