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What to do With a 401k When You Change Employers?

401(k) 401k plan retirement retirement plan

Life happens, right? Odds are you're going to change jobs once or twice in your career. And a common question I get is, well, what should I do with my 401k when I change employers?

Well, first off, let's just take the whole cash out option off the table, since we don't want to withdraw it.

Why? Because you're going to pay income tax on the balance that you're going to withdraw. And if you're under age 59 and a half, you're going to also pay a 10% penalty. And I mean, heck, you do need the money for retirement, so let's just keep saving, not cash it out. But there are three options then that you can weigh and figure out which one's the best for you.

The first option is you could just leave it where it is. You can leave it with your previous employer and really do nothing. Your second option is you could roll it over into an IRA that you set up in your own name, and the third option is you can consolidate it or roll it into your new employer's 401k. So, let's just take a little look at the pros and cons of each and see which one might be the best for you.

With the first option of leaving it with your old employer, most employers have a minimum balance. they'll let you leave. Typically, if it's under say, $5,000 or so, they're going to want you to roll it somewhere else. They don't want to keep track of it. But if it is more than that, of course it's the easiest one, and you can just leave it as it's invested. The big disadvantage I see, honestly, is you sort of tend to lose track of it. You don't pay as much attention to how is it being invested. I've even had clients who have lost track that they even had an account and then they scramble 20 years later try to figure out where it's gone. So honestly, not my favorite choice.

The second option is you can roll it over into an IRA in your own name, so it’s easy. A benefit is that rollover is tax deferred. There's no tax to you to do that. It doesn't matter how old you are, you would simply open an IRA in your name at, say a brokerage house, like a TD Ameritrade or a Schwab or a Fidelity. Assuming it's a pre-tax 401k, you want a traditional IRA. If it's a Roth 401k, you'd open a Roth IRA, and then just instruct your previous employer. They'll either have paperwork or you'll log into your account to give the instructions to say “Hey, roll it over directly into this IRA.” They call it a trustee-to-trustee transfer. It just goes straight there and it’s super easy. But be careful because once the money arrives, it's going to be in cash. They're going to just park it in a money market. So, don't leave it uninvested in that new IRA. You're going to need to choose how do you want that account to be invested, which mutual funds, which ETFs, etc., that match, of course, your risk tolerance in your age until retirement.

And then your third option is that you could actually roll it into or consolidate it into your new Employer's 401k. People will typically do this, perhaps if they're young, and their balance isn't particularly big to put it in an IRA and have to keep track of it, so they just want all their 401k money consolidated into one account. Keep in mind, your new employer's plan must specifically allow for incoming rollovers, although most employer plans I have found do accommodate that. So, the advantage of that, again, the money's all in one place and then you would just be choosing to invest it from the choices that the new employer has provided you.

So, there's not really, “always do this, or always do that.” It's going to depend on, well, how big is the dollar amount at the previous employer? Do you want to keep track of it in a separate account? Do you want to just keep it easy? And honestly, how good are the investment choices that your new employer's offering you? If they're pretty limited and you want to have the variety that you could have in an IRA, then that might sway you that way.

You know, one tip I'll throw out to you while this money's moving around, whether you're, leaving it, whether it's rolling to an IRA, whether you're putting in a new plan, it's always a great time to check your beneficiary designations. Make sure you have a primary beneficiary designated and a contingent or backup beneficiary designated. If you don't and it's left blank or even if it's left to your estate, then the tax consequence to your heirs is worse or more burdensome than if they are named outright as a beneficiary. We'll get into that more in other topics, but just to say, it’s great time to check your beneficiaries and make sure you've got somebody named.

So, I hope this helps, congrats on that new job, and keep on saving, because never forget, your future self is depending on the current you. Thanks so much.

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