What to Do With Your Old 401(k)?

Investment Guidance
what to do with your old 401(k)

Job changes are increasingly relevant to today’s young professionals, and with them comes the inevitable decision around what to do with your old 401(k). Do you leave it in your old company’s plan or take it with you to your new employer? Should you roll the money into an IRA or cash out the balance?

Before making any decisions it is important to fully understand all of the considerations that should be factored into your decision and the implications of each of your four primary options.

Cash Out Your Balance

Once you’ve terminated employment with your current employer, you can withdraw your 401(k) assets in a lump sum. To do this, you simply instruct your 401(k) plan administrator (i.e. Fidelity, Schwab) to send you a check. From there you can use the money to meet expenses, put it toward a large purchase, or invest elsewhere. In short, you’re free to do whatever you’d like with the money.

However, proceed with caution!

While cashing out is certainly tempting, it’s almost always a bad idea. Taking a lump sum distribution from your old 401(k) can significantly reduce the hard earned savings you’ve amassed for retirement and is generally not advisable unless you urgently need money and have no other alternatives. Not only will you miss out on the continued tax-deferral of your 401(k) assets, but you’ll also face an immediate tax bite and a 10% penalty if you are under 59.5.

Leave with Your Old Employer

Your 401(k) assets will continue to grow tax deferred, but you will no longer be able to contribute or receive any contributions from your previous employer. However, if the vested portion of your 401(k) balance is less than $5,000, your former employer may require you to remove the assets from the plan.

Leaving your money in your old employer’s 401(k) plan may be advantageous for a number of reasons. First, you might be looking to take some time to evaluate your alternatives and if so most providers will allow you to keep the money in the plan (again, assuming the balance is greater than $5,000).

Another reason you might consider keeping the money in your previous employers plan is if you’re happy with the investment options offered through the plan. Many large plans are able to offer their employees very inexpensive fund lineups due to the size of their plans, which means funds can oftentimes be less expensive than what you’d be able to pay as an individual or at a smaller company (i.e. think buying at Costco versus purchasing at a small retail store).

Transfer into Your New Employer’s Plan

If your new plan allows it you can always roll the assets from your old 401(k) plan into your new one, once you are eligible to participate. Check with the HR Department or the 401(k) plan provider to determine if your new plan accepts rollovers into the plan.

Typically, the easiest way to transfer funds from your old 401(k) provider to the provider of your new 401(k) plan is to initiate what is referred to as a direct rollover. As technology has evolved, this transfer has become more and more seamless, allowing your retirement savings to remain tax deferred without even a temporary interruption.

The other advantage of a direct rollover is that once the paperwork is completed, the money is moved directly to your new employer’s retirement plan and you do not have to handle the money, which helps to ensure the money will remain tax deferred and that no penalties or taxes are incurred. Direct rollovers also do not require any taxes to be withheld, while indirect rollovers (a check is mailed to you and then you have 60 days to deposit the money back into a tax-deferred vehicle) do.

Transfer into an Individual Retirement Account (IRA)

Rolling the assets into IRA typically provides greater flexibility when it comes to managing your hard earned retirement dollars. Your balance will continue to grow tax deferred in an IRA, but you will oftentimes have a wider array of investment options to pick from. Once the money is transferred into an IRA you may also have the flexibility to have a financial advisor manage the money depending on your needs and preferences.

Rolling your assets into an IRA can also provide additional flexibility when it comes to taking withdrawals. For example, once the money is transferred into an IRA you are now able to withdraw money prior to age 59.5 with no 10% penalty if the withdrawal amount is being used to make a down payment on a first home or for education expenses. In both cases you will still pay taxes on money withdrawn.

Which Is Best For You?

With so many considerations and a number of different options, how does one determine the best course of action for their individual circumstances? It all comes down to determining what is best for your situation. For many rolling the money into an IRA will be the best option, but for others it might make sense to roll the money into a new employer’s plan.

Here are a few final points to consider before deciding what might be best for you:

  1. 401(k) plans limit you to the investment options made available through the plan, while IRAs can offer nearly unlimited investment options
  2. Due to scale, some large 401(k) plans may have lower pricing than you will be able to get in an IRA or in your new employer’s plan, so be sure to consider costs when navigating your options
  3. 401(k) plans are fully protected against creditors in the event someone ever came after your assets in a lawsuit; IRAs are typically limited to only $1 million in creditor protection
  4. Many 401(k) plans will allow you to take a loan against the value of your account; IRAs do not
  5. Money can be withdrawn penalty free from an IRA for first-time homebuyers and for qualified education expenses; you cannot do either with a 401(k)
  6. Some 401(k) plans will allow penalty-free withdrawals prior to age 59.5 and after age 55; IRAs do not provide this flexibility
  7. Required Minimum Distributions (RMDs) are required with IRAs (not Roth IRAs), but not with 401(k) plans until you retire
  8. If you have employer stock in your 401(k) plan you may be eligible for favorable tax treatment


About Matt Cosgriff, CFP(®)

Minneapolis Financial Planner | Intrapreneur | Young Professional | Millennial Guru | Tech Aficionado | Traveler | Food Lover | Minnesota Wild Fan | Movie Quoter | Follow on Twitter| LinkedIn

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