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Should I Roll Over my 401(K)?

How many jobs, or even careers, have you had in your lifetime? Do you feel that you’re in your final company in your career? If you’re like most Americans, you’re surely not. In fact, about 30% of the workforce changes jobs every year, the average American has twelve jobs in their lifetime, and 96% of Americans were looking to change jobs in 2023! What does that mean for your retirement planning? If you’re contributing to a workplace retirement plan such as a 401(K), then the implications are significant – you need to decide what to do with the savings you’ve thus far accumulated in your plan. 

This article aims to shed light on your options along with the pros and cons of each.

Leave Your Savings In Your Old 401(K)

Your first option is to leave your funds where they are if your former employer allows it. As of 2024, you may need to have at least $7,000 worth of assets to be able to do so. If you have less than that in your 401(K), your former employer may automatically cut you a check or roll it over into an IRA. 

However, if you have the option to leave your savings in your old 401(K), you won’t be able to contribute any more funds to it. Additionally, you likely won’t be able to borrow against it if you require funds quickly. If you do make a withdrawal, you’re likely to have to withdraw all of the funds as well (not just a portion), and once you reach 73, you’ll have to begin making Required Minimum Withdrawals (RMDs), even if you are still employed with your new employer. 

Basically, you’re a lot more limited with what you can do with an old 401(K).

Roll Your Savings into Your New 401(k) Plan

Your next option is to sell the assets in your old 401(K) and execute a rollover to your new 401(K). 

There are two kinds of rollovers: direct and indirect. With a direct rollover, your funds are transferred from your old retirement account to your new retirement account without you ever touching the funds – this is the route you should strive for. 

An indirect rollover entails receiving a check for the amount of your savings and depositing it into your new 401(K) retirement account. If you go for the indirect rollover route (you may not have a choice), you have sixty days to conduct the rollover; failing to do so may result in penalties and taxes. 

Complicating matters is that your old 401(K) administrator may withhold 20% of your funds for tax purposes – failure to account for that 20% when you deposit your check can lead to early withdrawal penalties and taxes. 

For example, let’s say you have $100,000 in your old 401(K). Your company cuts you a check for $80,000, yet you still have to deposit $100,000 into your new 401(K) account. If you don’t, the IRS sees it as you making a $20,000 withdrawal that you’ll owe a ten percent penalty on if you’re under 59½, along with income tax. 

Once your funds have settled into your new account, you can go about purchasing the assets available to you in your new plan. If you’re 73 or over, you won’t have to take any Required Minimum Withdrawals (RMDs) as long as you remain employed.

Roll Your Savings into an IRA

You always have the option of rolling your savings into your personal IRA. Again, your funds will continue to grow on a tax-deferred basis (or post-tax if Roth). You’ll have to make Required Minimum Withdrawals once reaching age 73 from any tax-deferred funds, regardless of your employment status. Since your IRA is precisely that – yours – you won’t have to worry about what to do with your funds if you ever change jobs again. 

What to Choose?

While it’s difficult to give broad advice when every financial situation is different, there are some very general rules when deciding if and how to roll over your 401(K). 

Let’s start with your investment choices: if your new 401(K) has outstanding investment choices with low costs, perhaps your funds will grow faster in it. Alternatively, if your old 401(K) has better options with lower fees, maybe you should leave your funds there. Do both plans have poor investment choices? Well, in an IRA, the entirety of the stock and bond markets are available to you – you just need to know what you’re doing (or seek investment advice from a fiduciary financial advisor). 

Can you foresee needing to borrow against your 401(K)? Rolling your funds over to your new 401(K) gives you more chances to liquidate funds as necessary in times of emergency. 

What about rebalancing? Rebalancing your assets to remain aligned with your risk profile becomes increasingly complex with each new account. Keeping your accounts as consolidated as possible drastically simplifies the process, allowing you to have a more unified tax and investment strategy. 

If the only option is an indirect rollover and twenty percent of your funds will be withheld for taxes, can you come up with those funds? If not, perhaps keeping your old 401(K) is the best thing to do. 

Finally – will you remember your old 401(K)? Unfortunately, a shockingly high number of Americans do – in May of 2023, there were an estimated 29,200,000 forgotten 401(K) accounts. Consolidating accounts as often as possible will help prevent forgetting an account completely while simultaneously simplifying rebalancing procedures. What is a 10% penalty if you’ll just lose the funds forever when you eventually forget about your account?

Other Options

Cash Out Your 401(K)

You can always take a check and cash out your savings if you so desire. However, there will likely be consequences. Firstly, you’ll owe income tax on your withdrawal, and secondly, depending on your age, you could be hit with a 10% penalty. 

Thirdly, you’re reducing your ability to save for retirement. Savings can’t grow if they’re not properly invested. This option should only be considered in times of great financial need after exploring all other avenues. 

Convert to Roth

A rollover may be a good time to simultaneously execute a Roth conversion, especially considering the limitations of traditional retirement accounts. With traditional accounts, you’re required to pay taxes on withdrawals in retirement and take Required Minimum Distributions (RMDs) starting at age 73. However, converting to a Roth IRA changes your obligations.

Upon conversion, you’ll owe taxes on the converted amount, which could impact your tax situation for that year. But, after paying these taxes, Roth IRAs offer significant tax advantages. Qualifying withdrawals from a Roth are tax-free and don’t affect your taxable income, Social Security benefits, or Medicare premiums. Additionally, Roth IRAs can be left as a tax-free inheritance.

It’s important to note that after converting to a Roth, the funds must remain in the account for at least five years. Accessing the funds before this period elapses may result in an early withdrawal penalty and taxes on the earnings. Also, you’ll have to figure out how to pay your tax bill, which could be pretty sizeable depending on the conversion amount.

In Conclusion

So, what is the optimal route for your retirement savings? Should you leave your funds in your old 401(K), roll them over into your new 401(K) or personal IRA, convert all or some of your savings to Roth, or possibly just cash out? While this article outlined some very general rules, it’s vital to sit down with a financial advisor to consider every possible nuance and your employers’ rules regarding rollovers. 

Have you recently changed jobs and are unsure what to do with your former employer’s 401(K)? We can sit down with you and discuss each option’s implications on your retirement and tax plan and help you make a decision that makes the most sense for your financial future. Feel free to click the button below to schedule a consultation!

For informational and educational purposes only and should not be construed as specific investment, accounting, legal or tax advice. Certain information is based on third-party data and may become outdated or otherwise superseded without notice. Third-party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. The scenario mentioned in this presentation is not an actual client experience. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this presentation.

About the Authors

  • Douglas Walters

    Doug is the Managing Partner of Walters Strategic Partners, LLC, a licensed Registered Investment Advisory firm. Doug is a licensed Certified Public Accountant (CPA) in the state of Florida and holds a Series 65 Investment Advisor Representative securities license. He is also a member of the AICPA. With over 28 years of experience as a CPA, he believes investment decisions should be based on decades of peer-reviewed research rather than relying on the latest “hot tip” from media outlets. This empirical evidence puts the science of investing to work for his clients.

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  • Jose Joia

    Jose M. Joia is a Wealth Advisor at Walters Strategic Advisors, LLC. As a member of the team, Jose’s responsibilities involve comprehensive wealth management, planning and customer service. He has over 6 years of industry experience specializing in planning and solving unique issues his clients encounter. Jose has experience serving individual clients, business owners and non-profit organizations.

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