Updated for 2020. Have you ever wondered what you should do with an old 401(k)? When most of us change employers we’re so focused on what’s ahead that we often forget about the old 401(k) we may have left behind. When you leave a job, consider rolling over your old 401(k) or 403(b) into an IRA to maintain more control over your investments. You have a few different options for managing your old account – the three most common choices are highlighted here.
Option 1: Roll your old 401(k) into an IRA
May be suitable if you:
- Want to continue deferring taxes on your savings
- Want a greater variety of investment options
- Already use an IRA and want to combine your accounts so they’re easier to track
- Want access to professional investment advice from the Registered Investment Advisor managing your IRA
The most common option for managing an old 401(k) is to roll the account into a Traditional IRA. A Traditional IRA is a retirement account that you set up outside of work so it’s not connected to any one employer.
Like a 401(k), the Traditional IRA delay taxes on your retirement savings so you won’t owe any taxes upon conversion. When you contribute money to a Traditional IRA, you’re also able to deduct your contributions from your taxes, subject to income limitations.
Rolling over to a Traditional IRA is a popular choice because this account is very similar to a 401(k) so investors can keep saving for retirement without too many changes.
If you’ve already been saving in a Traditional IRA, this rollover is convenient because you can transfer the 401(k) money right into your current IRA. IRAs also typically offer more investment options than work retirement plans and can give you access to professional investment advice from the professionals managing your IRA.
Option 2: Roll your old 401(k) into a Roth IRA
May be suitable if you:
- Want to diversify your retirement planning through the use of an income tax-free account
- Can afford to pay the income taxes on your current 401(k) savings from another source
- Already use a Roth IRA and want to combine accounts
- Want access to professional investment advice from the Registered Investment Advisor managing your Roth IRA
Another option is to convert your 401(k) into a Roth IRA. The Roth IRA has different tax rules than the 401(k) and the Traditional IRA. This account delays its tax benefit until retirement – so you’ll pay now and benefit later. When you make withdrawals in retirement, the funds are tax-free so you don’t pay income taxes on your investment gains. Funds from a 401(k) or Traditional IRA are taxable.
In exchange, the Roth IRA must be funded with after-tax dollars. This means that when you roll over your 401(k), you’ll need to pay income tax on the entire account balance which can be expensive depending on the size of your 401(k). There’s a general rule of thumb that says if you cannot come up with the cash to pay the taxes due with non-retirement money, it usually isn’t advantageous to convert to a Roth.
A Roth IRA has two other main benefits compared to a Traditional IRA:
- Five years after you make your first regular contribution you’re able to withdraw funds for qualifying events without a penalty, even if you’re not yet reached retirement age. This allows investors to use funds for a down payment, if their savings isn’t sufficient.
- There are no required minimum distributions (RMDs) for Roth IRAs for the account owner and most spouse beneficiaries. This can allow retirees more options in retirement which could potentially reduce their overall tax bill. (Under the Secure Act, which was passed in 2019, beneficiaries who inherit a retirement account, including a Roth IRA, from a non-spouse (e.g. a parent or relative) can no longer 'stretch' the distributions over their lifetime by taking required minimum distributions (RMDs). Instead, they will be forced to take the funds in 10 years. The change won't impact anyone who inherited a retirement account during 2019 or years prior.)
Option 3: Keep your old 401(k)
May be suitable if you:
- Want time to consider your options
- Want to retire and start making withdrawals before you turn 59 1/2
- Have access to unique investment options that aren’t available in an IRA
- Need better creditor protection
Your employer might let you keep your assets in your old 401(k) even after you leave the company. This could be a good option in a few different situations. If you aren’t sure what you want to do with your 401(k) and want more time to decide, then leaving the money in your old 401(k) would give you this time while leaving all the other options open.
Also if you plan on retiring and taking out money before you turn 59 ½, an old 401(k) makes sense. You can start making retirement withdrawals from a 401(k) once you turn 55. You need to wait until you turn 59 ½, with an IRA.
If your 401(k) plan offered some unique investment options or investments at a lower cost than you can find for an IRA, keeping your money in the old 401(k) would allow you to continue using these investments. Finally, a 401(k) has better creditor protection than an IRA. In most situations, however, it usually isn’t beneficial to keep retirement savings in your former employers’ 401(k) program because of the lack of investment options and typically higher fees.
There’s often a lot to do when wrapping up one job and beginning another. Make sure you’re getting the most out of the assets in your retirement plans by investigating the options for your old 401(k). Wondering what you should do with an old 401(k)? Contact us today.