Moving That Old 401(K)
- Most Americans under the age of 50 will change jobs many times during their career.
- You want to be smart about taking your 401(k) with you from job to job.
- Cashing out is usually the worst strategy, even if you really need the money. Unfortunately, way too many folks do this.
Got 401(k) concerns? Contact us any time for advice.
Regular readers of this blog know that the No.1 good money habit our clients have is that they save first and spend second. Let’s talk about retirement savings, particularly if you’re under age 50. You’re going to change jobs throughout your career, and hopefully you’ll have a 401(k) at each stop. What do you do with your old 401(k) when you make a change? Do you cash it in? Do you leave it where it is? Do you roll it over into your new 401(k)? Do you roll it into an IRA?
Well, Hewitt Associates Inc. did a study about this topic recently and found that 46 percent of people cash in their 401(k). This is a horrible decision, as I’ll explain in a minute. The study showed that another 25 percent move it to their new 401(k) or an IRA, which is fine. Another three in ten (29 percent) just leave it behind at their old company, which is sometimes OK. Let’s look at each strategy closely:
- Leave it behind. The advantage here is that it’s easy to do, and hopefully it’s allocated correctly. The disadvantage is that you can start to ignore it and find out too late that it has drifted off-track from your goals. It’s not the best choice, but it’s better than cashing it in.
- Roll it over to an IRA. If you roll your old 401(k) over to an IRA, you can customize it, track it very carefully and keep it tax deferred. There’s no cost in doing it this way.
- Move it to another 401(k). You can go from one 401(k) to another 401(k) or to another qualified retirement plan. In the process of doing that, the money stays tax deferred. But there’s another really interesting facet: If the new plan has a loan option and you really need money for an emergency, then you can borrow it from the funds you have saved. Adding your old 401(k) money to it immediately creates a base you can borrow from, if necessary.
- Cash it in. Not a great idea. Suppose you are 30 years old, are starting a new job and have accumulated $20,000. If you cash in your 401(k) now, you must pay a 10 percent penalty because you’re under 59 ½ years old. If you’re in the 28 percent tax bracket, your $20,000 nest egg goes down to $12,400 after taxes and penalties. But if you rolled over your old company 401(k), then you’d still have $20,000. Using a conservative 7 percent annual rate of return, you’ll have about $132,000 by age 65, versus $213,000 if you had rolled it over. That’s an $81,000 mistake.
We know people are sometimes forced to cash in their retirement accounts because they need money to pay off loans, relocate or make a down payment on a house. But if you roll your 401(k) over rather than cash it in, you can still borrow against that money. It’s not the best choice, but it’s far better than cashing out.
The bottom line: If you’re moving from one job to another, the best choice is usually to roll over your old 401(k) to an IRA or a new 401(k). Also, keep contributing to your 401(k) in your new job, because you want to keep building your savings. You can’t expect corporate America to take care of your retirement anymore. Those days are over. If you or someone close to you has concerns about retirement accounts, make sure they talk to a qualified professional or contact us any time for advice.
Until next time, enjoy.
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