What you should do with your old 401k

What you should do with your old 401k is a common question we receive as financial planners each and everyday. And it’s a great question. Today we will break down the pros and cons of your choices.

Keep it at your former employer

Keeping your old 401k with your former employer is an option. Access to familiar investment choices. Likely lower costs. Broad protection from creditor claims under federal law. However, investment choices might be limited. Can’t make new contributions or take loans.

I like to compare leaving your old 401k with your former employer to leaving your favorite items in the home of an ex. When you leave your spouse do you feel your “stuff”will be safe there or should you take it to your new home? For some people the cost of leaving it might appeal to them. But I prefer to have my money where I can access it.

Move it to your current employer

Your new employer could give you access to potentially new investment choices. You avoid immediate taxes and a potential 10% early-withdrawal additional tax. Preserve tax-deferred growth potential. Moving it to your current employer is an option if your new employer has a 401k plan which accepts outside rollovers. There may be waiting periods or other restrictions. You need to read the plan rules before making that decision.

Rollover to an IRA

Completing a rollover to a traditional IRA allows for potential future tax-deferred growth. With a traditional IRA you can make contributions. You will typically have more investment choices and planning tools. Furthermore, you will have access to investment advice.

Similar to your employer sponsored plan early withdrawals are taxed and penalized. Loans are no longer available. With the potential for advice comes the potential for higher fees.

Convert to a Roth IRA

The Roth IRA is one of our favorite retirement vehicles especially for younger clients just starting out. However, a Roth conversion can bring many benefits to older investors as well.

Some of the benefits of a Roth IRA are the following. Withdrawals of contributions are federal income tax-free (taxes are paid at the time of contribution). Able to pass potential earnings to heirs federal income tax-free. Original account owner doesn’t have to take required minimum distributions (RMDs).

Receive a lump sum distribution

The least beneficial option of what you should do with your old 401k is to receive a lump sum distribution. This option will give you immediate access to your assets. It’s up to you what you do with it at that point. You can travel the world or buy that exotic car you always wanted. However, taxes will reduce the amount you receive. Once the cash comes out you cannot put assets back into former employer’s plan. You lower the opportunity for potential tax-deferred future growth.