Left Your Job? What to Do with Your 401(k)
Why a 401k rollover could be a smart financial move
What is a 401k?
Let’s start from scratch by going over what a 401k is: A 401k is a work-sponsored retirement plan that allows employees to contribute a percentage of their income. The money set aside from your paycheck is then invested in funds that hold stocks and bonds.
If you want to learn more about the 401k plan itself, check out my full guide here: What is a 401(k) plan?
Benefits of a 401k
A 401k offers many benefits and is one of the best ways to save for retirement. Here are a few key advantages:
Company Match: Your employer contributes money to your 401k up to a certain percentage of your salary. This is literally free money!
Direct Payroll Contributions: A 401(k) allows you to automatically contribute a portion of each paycheck directly into your retirement account, making investing consistent and effortless.
Tax Advantages: Contributions come with tax benefits, either reducing your taxable income today (traditional) or allowing for tax-free withdrawals in retirement (Roth).
Your employer will use a custodian like Fidelity, Charles Schwab, or T. Rowe Price to create and manage your 401k plan. These companies partner with your employer to handle contributions, company matching, and investment options. In exchange for these services, the custodian charges fees to maintain your account.
Since your 401k is sponsored by your employer, when you leave that company, you are no longer eligible to contribute to that plan. Now, that doesn’t mean that your money disappears and you lose your contributions, you just can’t contribute moving forward. The money you contributed always remains yours, and employer contributions remain yours as long as you are fully vested.
What Happens to Your 401k When You Leave a Job?
You have a few options with your 401k when you leave a company. The decision you make here can impact your long-term growth and how easy your finances are to manage. Let’s break down each option.
Option 1: Leave Your 401k With Your Former Employer
This is the default option and one that many people choose because it requires no action. However, it’s usually not the best long-term move.
High Fees
Even if you’re no longer contributing, your old 401k still carries administrative and investment fees. Over time, these fees can quietly eat into your returns and potentially cost you tens of thousands of dollars.
Limited Investment Options
Most 401k plans offer a limited selection of funds. Remember, they partner with a custodian to create and manage your plan, which includes investment selections. Even if better options exist, your plan restricts your choices. These funds may also have higher expense ratios that you don’t control.
Forgetting About the Account
Imagine you spend two years at a job and invest $5,000 into your 401k, with your company matching another $5,000. That’s $10,000 saved, nice work! You leave the job, forget about the account, and lose track of it over time. By retirement, that $10,000 could grow significantly to be worth well over $100,000 – but you can only use it if you remember it’s there.
Consolidation / Simplification
Over the course of your career, you could work at many different companies. If they all offered 401k plans, it can be hard to keep track of all your accounts and log-in information. It would be much easier to consolidate all of them into one account that you can easily manage. This will make your life much easier!
Option 2: Roll Your 401k Into an IRA
This option is typically the best option! An IRA is an Individual Retirement Account, and is another way to save for retirement. The key is to request a direct rollover, so you avoid taxes and penalties. Here’s what makes the IRA so beneficial:
Tax Treatment
An IRA and 401k follow similar tax rules and hold the same retirement age requirement to start withdrawing from the account (Age 59 ½). At that point, you can withdraw from the IRA tax and penalty free!
Lower Fees
With an IRA, you are no longer tied to an employer plan. This allows you to choose a provider with low-cost investment options, giving you full control and allowing you to keep more of your money invested and growing.
More Investment Options
An IRA gives you access to a much wider range of investments compared to a 401k. You can choose options that align with your goals and minimize costs.
Simplification of Finances
You can roll multiple old 401ks into one IRA over time. This keeps everything in one place and makes managing your finances much easier.
Option 3: Roll Your 401k Into Your Current Employer’s Plan
This is a solid backup option to option #2. Taking your plan with you to the new employer keeps your accounts in one place, but you are still limited with investment options and fee structure.
Now that we’ve gone over the 3 options, you can see why rolling your 401k into an IRA is often the most beneficial choice, with rolling into a new employer plan as a solid alternative.
The key is to avoid doing nothing with your hard earned money! (don’t leave your 401k behind!)
A Simple Framework for a Rollover
The rollover process is straightforward and can be broken down into a few key steps:
Decide where your funds will go (IRA or new company 401k)
If choosing an IRA for the first time, you’ll need to open a new account
Initiate the rollover with your current provider
Provide details for a direct rollover like the account number, institution name, and mailing address.
Confirm and allocate your funds
Once the transfer is complete, you will receive the funds, and choose your investment selections
That’s it! You now understand how to take control of your 401k and make a smart move for your future.
For more finance tips delivered directly to your inbox, subscribe to the blog!
