EASY MONEY

The Fruitful perspective on demystifying everyday finances

SHOULD YOU ROLL OVER THAT 401(k)?

QUICK TAKE

You have options when deciding what to do with a 401(k) from a former employer. You can do a rollover into a new employer’s plan, convert to a Roth IRA, or cash out (but don’t cash out if you can avoid it).

LOTS OF 401(K)s GET LEFT BEHIND

At the start of 2022, one analysis estimated that Americans had left about $1.35 trillion in 401(k) accounts with former employers. That’s a lot of 💰!

If this is your situation, what do you do?

You’ve got options

Many organizations allow you to keep your 401(k)s in their plan, even after you’ve left.

So that’s one option — do nothing.

But there are more to consider:

  • Roll over into new employer plan
  • Do a direct rollover into a traditional IRA or Roth IRA
  • Convert to a Roth IRA
  • Cash out

Let’s look at each option.

1. Keep in former employer’s plan

You can leave it where it is (but don’t forget it exists). Pros and cons include:

  • Convenience — Doing nothing is usually the easiest option!
  • Tax — The money continues to grow tax-deferred (you won’t have to pay taxes until you withdraw it)
  • Cost — It might cost less to leave it where it is. Or it might cost more than moving it elsewhere. You also might have fewer or more investment choices. So you have to compare options before deciding.


2. Roll over into new employer plan

Another obvious choice is to roll each former employer 401(k) into the next employer’s plan. Pros and cons to this:

  • Consolidation — Combining money into one account makes it easier to track. That’s a big pro for many.
  • Cost — Similar to keeping your 401(k) in your former employer’s plan, the cost and choices might be more or less. So, compare your options.

3. Do a direct rollover into a traditional IRA or Roth IRA

If you don't have access to your next employer plan yet, don't like the investment options or fees, or maybe they don't offer one at all, you can always do a direct rollover from a 401k to an IRA. That new account will technically be called a Rollover IRA. (If you have Roth 401k money, make sure those dollars get rolled directly into a Roth IRA.) Hot tip: Never contribute to a Rollover IRAs — instead open a new IRAs and put your contributions there. Then in the future, you maintain the option of moving those Rollover IRAs into your new employer plan without dealing with messy commingling of rollover and non-rollover funds. Direct rollovers shouldn't have any tax consequences


4. Convert to a Roth IRA

A Roth Individual Retirement Account is one where the money goes in post-tax and comes out tax-free. That’s compared to accounts like 401(k)s where the money goes in and grows pre-tax and gets taxed when you withdraw it. So converting a 401(k) to a Roth involves taxes. Some pros and cons:

  • Taxes — The con happens when you roll over a 401(k) into a Roth IRA. You’ll owe income tax on the amount because you’re converting pre-tax dollars to post-tax dollars. The pro happens later — Roth distributions after the age of 59½ are tax-free!
  • Distributions — This is another pro that happens later. Unlike traditional IRAs or 401(k)s, where the IRS requires you to withdraw a certain amount each year in retirement, Roth IRAs don’t have this “RMD” or Required Minimum Distribution rule. You can withdraw whatever with no penalties.

5. Cash out

Taking your 401(k) out in cash is rarely a good option, unless you absolutely need emergency money right away. With some exceptions, emergency cash is the only pro – the rest are cons:

  • You pay ordinary income tax on the withdrawal
  • 10% early withdrawal penalty — If you cash out before 59½
  • 20% penalty withholding by plan custodian — unless your distribution is for a hardship or a loan

Are you a special rollover case?

There are a few special cases where you should definitely consult with an expert before rolling over. These include if you have:

  • Appreciated employer stock in your 401(k)
  • A state pension
  • Legal issues where your money is at risk from creditors

It’s really up to you

Because rolling over your 401(k) usually means converting it to cash and mailing it to the new custodian or trustee, you might not want to do it in a volatile market, because you don’t have control over what day the check is cut.

And while we can educate you, it’s your decision what to do with your 401(k). Schedule an appointment with a Fruitful Financial Guide to weigh your options.

DISCLAIMER

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