What Should I Do With My Old 401(k)?

Quick Summary

• You've got four options with an old 401(k), and one of them is leaving it right where it is.

• Once money leaves a 401(k) you generally can't put it back, so it pays to slow down and get it right the first time.

• The answer starts with your situation: your age, when you'll need the money, and your tax picture.

• Rules and investments vary from employer plan to employer plan and from one account type to another, so know what options and features exist.

• Special tax rules can let you access your money without penalty and manage your taxes. Each move could impact another move you want to make.

• Everyone advising you on a rollover has a conflict of interest, no matter how they're paid. It's fair to ask what changes for them if you move it.

This is the big question that caused a client to reach out to me for financial advice, and funny enough, it was already on my list to write about.

You change jobs and the old 401(k) stays put because you’re not sure what to do or forget about it.

The investments inside keep doing whatever they were doing when you last checked, which may not be what’s best today.

Maybe you picked something aggressive when you were 28 and it's still aggressive now that you're 47. Maybe you went the other direction, and it hasn’t grown much because it was invested too conservatively.

Years later you know you’ve got two or three of them scattered around because statements keep showing up in the mail.

My name is Michael Hollis, and I help people in Aurora, IL, Chicagoland, and virtually across the US work through questions like this one. What follows is general in nature and not specific investment advice.

You have four options for an old employer 401(k)

There are generally four moves you can make with your old 401(k). Here they are in no particular order.

1. Leave it where it is. You don't have to roll it over. The money stays in your old employer's plan; you keep that plan's investment menu and its protection against creditors taking it to satisfy your debts. It might also help you preserve a couple of tax strategies you intentionally want to use. (more on that below)

   You've also got one more account to keep track of and investment selections to manage. One caveat, when you leave an old job, plans often force small balances out whether you intentionally choose that or not.

2. Move it to your new employer's plan. If your current plan accepts incoming rollovers, and many do, you can bring the old money to your new employer's plan. That consolidates accounts and follows the new plan’s rules and investment choices. But maybe the new plan’s investment options aren’t the best or costs are higher than in your old plan.
   

3. Roll it into an IRA. The money goes into an account in your own name, removed from any plan’s rules and often at a lower cost. You pick the company that holds the money for you (a custodian), and when it comes to investment choices the world is typically your oyster. Having said that, some investment advisors have a more limited scope of investments which may not be optimal or have higher fees. You may also end up with more accounts, since pre-tax and Roth dollars have to sit in separate IRAs. And it can complicate or eliminate some of the tax strategies available to you. (more on that below)
   

4. Take the money out. This is a major decision point because, depending on your situation, it will mean you’re including the withdrawal in your taxable income for the year and/or paying a penalty for triggering certain tax rules.

   For people under 59 ½, you could pay income tax plus a 10% penalty, and you've permanently unplugged the money from tax-deferred or tax-free compounding.

   For others who meet exceptions or where other rules apply, it could be the right move. (I promise we’ll get to this below. 😂)

   Whichever way you go, understand that once money leaves a 401(k) you generally can't put it back or unwind the taxes.

   So, slow down and make the best choice. Nothing here is usually on fire, but don't drag your feet either.

How should I decide what to do with my old 401(k)?

Before you start, you need to download the Summary Plan Description for each employer plan, so you have it ready in step one.

I’ve witnessed situations where people make a choice without being thorough, only to have a real mess on their hands. The financial planning process I use breaks the answer down into five steps, so you minimize headaches.

1. Understand your situation, not just the account.  That includes: • Your age • When you need the money • Your tax picture now and later • What your wealth is for.

   Somebody who's 41 and won't touch this for twenty-five years is answering a different question than somebody who's 56, thinking about leaving a job that's worn them out, and the account is their entire nest egg.

   Then do your diligent reading of the lovely Summary Plan Descriptions.
   

2. Analyze the courses of action. All four of the options above, measured against what you learned in step one.

3. Refine the possibilities. Rule out the ones that clearly don't make sense.

4. Decide the direction. The best option in the universe of possibilities, whether that turns out to be through my firm or on your own.

5. Execute. This sounds like the simple part, but depending on the custodian, this can be annoying.

Some rules & plan features to know

Here’s a non-exhaustive list of other interesting factors to consider. A lot more could be said about each, and it’s worth considering your specific situation with a financial pro who understands taxes, before you take any action.

Getting to your money before 59 1/2. So much hullabaloo is made that "your money is locked up" in your 401(k). There's some truth to that because the law incentivizes saving for the future. But the law also makes provisions for those of us retiring before that magical age to avoid early withdrawal penalties. Here are a couple that might be available to you:

• The rule of 55 lets you take money from the plan of the employer you just left without the penalty, as long as you separated in or after the year you turned 55. The catch is that it only applies to that one plan. Move the money into an IRA or into your new employer's plan and you lose the option, and it does nothing for the 401(k)s sitting at jobs you left years ago.

• Substantially equal periodic payments, sometimes called 72(t), let you take a fixed stream of withdrawals based on your life expectancy at any age from either your employer plan or an IRA without the penalty. But you have to commit to taking the payments for five years or until you turn 59 and a half, whichever is longer. Making a change to the payment or stopping early brings back the penalty on every payment you took.

Roth conversions and the backdoor Roth. Roth is a hot topic because many assume contributing or converting to Roth is best (I’d quibble with that). Given their popularity, there are a couple points to consider.

• If your income puts you over the annual limit for making direct Roth IRA contributions, you may consider “backdoor” Roth contributions. If you’ve moved pre-tax money into a traditional IRA, though, that complicates the strategy because it impacts how the taxes are calculated on the conversion part of the backdoor.

• On the other side of it, your old or new plan may not allow Roth conversions, so a pre-tax IRA is the only account available to execute that strategy if it makes sense.

Distributions and RMDs. When you eventually want income to come out of your retirement accounts, the available features make that easier or more complicated.

• Can you automate payments or does somebody have to call in and request it?

• How often can you make a withdrawal (monthly, annually, anytime)?

• What control do you have over which investments are sold to generate the cash?

• How do tax withholdings work on the way out?

These feel like small operational details until you're 73 and dealing with them every year. An IRA generally gives you greater flexibility in every which way.

Employer stock. If a meaningful piece of that old 401(k) is stock in the company itself, get help before you move anything. There's a tax treatment called net unrealized appreciation (NUA) that can save real tax dollars. With NUA, you can treat the gains that built up in your company stock as capital gains instead of ordinary income, which could mean you pay a more favorable tax rate.

That treatment goes away when you roll all your company stock into an IRA, and you can't undo it. Your tax rates, expected future tax rates, company health, and many other factors influence what to do.

Creditor protection. Workplace plans carry strong federal protection against someone you owe money to coming and taking your retirement funds. The protection an IRA affords depends on your state and varies. Tons of rules around this, and I don’t want to mis-state or oversimplify, but I generally weight this factor low because most people don’t have to worry about it.

Executing a rollover

Say you've decided to move your old account. Somebody has to do the work, and how much work it is varies a lot because each financial institution has its own process. Some require filling out paper forms (believe it or not) and others are completely electronic.

Understand the process you're dealing with before you start to save some headache.

The money moves out of the plan in two ways:

1. Indirect rollover. The check is made out to you. The plan has to withhold 20% for federal taxes, and you've got a 60 day window to get the full amount into the new account. That means you have to cover the 20% somehow while you wait to get it back when you file taxes next year. (Not ideal)

2. Direct rollover, also called a trustee-to-trustee transfer. The check is made out to the new custodian for your benefit, not to you (Very normal). No withholding so nothing to cover out-of-pocket. The check might still get mailed to your house for you to forward along, which is common and perfectly fine, or it might go straight to the new custodian. Maybe the whole thing runs electronically. (Best)

What to watch for at the very end

When the money reaches the new account, know that the funds don't always get automatically invested. Rollover money arrives as cash most of the time and could just sit there if you don't do anything. I've known folks who find out much later that the rollover funds have been earning savings account rates the whole time.

One thing worth knowing about whoever's advising you

Advice to roll over your 401(k) carries an inherent conflict of interest, and it exists regardless of how the adviser is paid. The commission and asset-based (AUM) fees most advisors operate under create an incentive to move your money to something they manage, because in both cases the adviser gets paid more.

That doesn't make the advice wrong, but it does mean it's fair to ask the person telling you to roll it over how their compensation changes if you do.

I charge one inclusive flat fee based on the complexity of your situation. If you roll funds to an account I manage, my fee stays the same. If you leave it with your old employer, my fee doesn’t change. That's the entire point of the flat-fee structure.

Which is also why step four up there isn't just marketing.

I'm not interested in handing you the least bad option I happen to have lying around.

If you've got a couple of old accounts scattered out there and you'd like somebody to sit down and look at them with you, we'll work out together which of the four options you ought to choose.

FAQs

What are my options for an old 401(k)?

Four. You can leave it in your old employer's plan, move it to your new employer's plan, roll it into an IRA, or take the money out. Taking the money out usually means income tax on the withdrawal, plus a 10% penalty if you're under 59½.

What is the rule of 55?

The rule of 55 lets you take money from the plan of the employer you just left without the 10% early withdrawal penalty, as long as you separated in or after the year you turned 55. The catch is that it only applies to that one plan. Move the money into an IRA or into your new employer's plan and you lose the option, and it does nothing for the 401(k)s sitting at jobs you left years ago.

What's the difference between a direct and indirect rollover?

It comes down to who the check is made out to. In a direct rollover it's payable to the new custodian, so there's no withholding and no deadline, even if the check gets mailed to your house for you to forward along. In an indirect rollover the check is made out to you, the plan has to withhold 20% for federal taxes, and you have 60 days to get the full amount into the new account, which means covering that 20% yourself until you get it back at tax time.