To Roll or Not to Roll?

What should I do with my old 401(k)?

This is a a question I get often from friends and family. If you are in the middle of switching careers, your former employer 401(k) can often get lost in the shuffle.

As a quick recap, a 401(k) is one of the many benefits provided to employee’s by their employers. The purpose of the account is to help the employee save for retirement in a tax advantaged manner. With a new employer comes a new 401(k) and a decision to make with the old employer 401(k). Sharing with you all your four options for your old 401(k).

1. Keep at Old Firm

I’ll start with what I see most often when meeting with prospective clients which is keeping the old 401(k) at the old firm. I lovingly refer to these 401(k)s as “orphaned 401(k)s” because in many cases, the account owner has forgotten about them until they pulled together all their financial statements for our meeting.

There is nothing wrong with leaving the 401(k) with the old company but the issue is that the account is at risk of being overlooked or not monitored on a regular basis. Leaving any account unchecked for too long can be problematic especially if the account is no longer invested appropriately for the investor’s needs.

2. Roll into new 401(k)

The second option with an old 401(k) is to consolidate those funds into the new employer 401(k). There are benefits that come from the decisions to roll into your new 401(k) which include account consolidation (a.k.a simplicity) and continued investing. A secondary benefit to consolidating 401(k)s and not opening an IRA is that the account owner retains their eligibility to make Backdoor Roth contributions. Backdoor Roth contributions can be a great financial planning tool for the right client situations and is a whole blog post within itself. Stay tuned.

The drawbacks of rolling into the new 401(k) is that you are limited on the investment options. Each 401(k) plan administrator has an investment lineup that could be limited to 30-50 investment options. This could be a positive in the sense the investor is not overwhelmed by investment options but in most cases this subset of investment options is on the more expensive side of the spectrum. This is in comparison to the alternative to rolling into the new 401(k), the rollover IRA which will be addressed in a minute. offers unlimited investment options at lower expenses. In my post on millennial’s selecting advisors, I expand on the concept of expense ratios.

3. Rollover Individual Retirement Account (IRA)

The third option account owner have with old 401(k)s is opening up an Individual Retirement Account (IRA) and rolling over the assets, tax free. I mention the tax free part because if done correctly as a “direct rollover” your account will preserve its tax characteristics of being pre-tax and growing tax deferred.

I know, lots of jargon but the bottom line is that the account will continue to grow just as if it were still in the 401(k) environment. The benefits to rolling the funds out of the 401(k) and into an IRA include the already mentioned expanded investment options. Another benefit is the ability to work with an investment professional to manage the investments and monitor on your behalf moving forward.

The drawback of pursuing a rollover is losing the ability to make Backdoor Roth contributions, which may or may not be a meaningful planning tool in the first place. It is all dependent on the account owner’s financial situation and aspirations.

4. Lump-Sum Distribution

I debated if I should even include this on the menu of options. I am not an advocate of cashing out a 401(k), especially if you are a young professional in accumulation phase. While I think it’s a bad money decision, this blog is for providing education and not judgement and this is in fact an option for an old 401(k).

It’s important to understand that if you decide to make a lump-sum distribution out of an old 401(k) that it will be a taxable event and you will be required to pay tax on the distribution AND a 10% penalty if you are under the age of 59 1/2. The penalty comes into play because the purpose of a 401(k) is to accumulate savings for retirement, the penalty was put in place to encourage account owners to reserve those assets for retirement unless absolutely needed.

If you find yourself with an old employer 401(k) I hope you found this post insightful and beneficial. The best option for your financial situation might not be the best option for a friend or family member. If you have a question about your specific situation, feel free to reach out!

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