Have you left an employer and your 401(k) with them?
I recently received an email asking about what to do with a 401(k) plan that was left with a former employer. Here was the question:
I would like your opinion on the following; my wife is beginning a new chapter in her career and starting a new job after 11 years. She has a 401k with a significant amount of funds and now we have to make the decision on what to do? The one decision that has been made is that we will not withdraw any money from the account, but we are not sure what our best option is:
1. Keep it as is within her old company’s 401k plan? I am not a fan and I know that we could incur administration fees plus we have a limited investment selection.
2. Rollover into her new company’s retirement plan? My reservation with this option is again having limited investment options.
3. Fidelity has a 401k rollover IRA plan that allows us to have full control of our investments (funds, stocks, etc.). I like this option but I know you are fan of ROTH IRAs better, but if we try to convert from a 401k to a ROTH IRA—would we get taxed?
We believe the best option is #3 but I value your opinion and your expertise which will help finalize the decision. I appreciate your time and look forward to your feedback.
Thank you, Ray
I’m glad you didn’t have “cash out” in your list of options! You know that would be the worst and most costly mistake and you won’t even get all of your money.
If you cash out, your employer is required to hold 20% for the IRS and you have 60 days to put it into a qualified retirement account or it’s taxed as ordinary income, plus any state tax that’s applicable. If you’re under age 59-1/2, you’ll also have a 10% penalty to pay, so you can see, that’s not a good option!
The first option you mentioned was leaving it with her old company’s 401(k) plan. Keep in mind, since she’s no longer an employee, she can’t make any more contributions to it. While that’s where most people end up leaving their money (by default), it’s not the best choice. As you said, you have a limited investment menu.
Most 401(k) investment menu’s are quite restrictive, offering one or two choices per asset class. It’s like trying to do your grocery shopping at Starbucks instead of at the grocery store! In the grocery store, you have all types of possible food available to you, not just a few things. So you can see why you will want to roll over your 401(k) into an IRA so you can have the whole grocery store available!
You might be able to take a loan against it if you need to, but if you already have one against it, you have to pay it off before moving it, other wise it will be treated like a taxable distribution.
The same “grocery store reasoning” goes into why you don’t want to roll it into her new company’s retirement plan. It’s a limited menu. For example, you know I’ve been talking about how tangible investments are making a comeback and paper investments are going out of favor. Most 401(k) plans have several paper choices (ST bond, Long-term bonds, High Yield bonds, International or Global bonds, etc.) and NO (ZERO) precious metals, agriculture, commodities, or mining stock choices.
I agree with you, option #3, rolling it over into an IRA is your best solution. Set up a new brokerage account before you start the transfer. Then make sure the funds go directly to the new account and not to you. It’s called a trustee to trustee transfer. Otherwise, if the check comes to you, 20% is withheld and if not rolled over within 60 days you’ll be taxed. You get the 20% returned when you file your taxes. That’s not a good scenario, so go for the trustee to trustee transfer.
You mentioned that there are sizable assets in the 401(k), so I wouldn’t think a ROTH IRA would be feasible. Of course you’d have to qualify to be able to open a Roth IRA by not exceeding the income limits and you’d have to pay tax on your 401k. That doesn’t sound like a good plan in your case. Just roll it into a traditional IRA.
Once you have the money in your brokerage account, not only can you invest in mutual funds, but ETFs, stocks, master limited partnerships, etc. that you didn’t have access to before. You can broaden your diversification and widen your investing horizons.