If you're like most people, you aren't going to be in the same job for your entire career. In fact, the average 25 year old has already worked more than six jobs since turning 18, and some experts project that millennials will work 12 to 15 jobs in their lifetimes. So, odds are you'll end up with one or more 401(k) accounts from former employers, and you'll need to decide what to do with them.
You basically have three choices. You can cash out the money, keep the money in your former employer's plan until retirement, or you can roll it over to another qualified retirement plan. So, which is right for you, and how should you go about it?
Whatever you do, don't cash out early
I don't want to say there are absolutely no circumstances that justify cashing out a 401(k) early, but that statement is pretty close.
Other than emergency expenses like unforeseen medical bills, or if you've been out of work for so long and have no other options, it's hard to make a good case in favor of cashing out. Not only will you have to pay your marginal tax rate (both federal and state) on the entire amount of the account, but you'll also be on the hook for a 10% penalty, unless you made the withdrawal for a "qualified" reason. Wells Fargo has a helpful calculator to emphasize the full financial impact of an early withdrawal, and the actual costs of cashing out can be quite high.
For example, if you have $30,000 in a 401(k) and decide to cash it out, you're likely to find yourself on the hook for $9,000 in additional tax liability once April 15 rolls around.
Some good reasons to keep it where it is
This isn't my favorite option, but it makes a heck of a lot more sense than cashing out. And, there are actually some pretty sound reasons for keeping your money in your former employer's plan.
For example, 401(k) plans tend to offer very low-cost investment options, and if you plan on investing in mutual funds, the fees are definitely worth comparing. Basically, corporate plans can invest in "institutional" mutual funds. Think of it as the difference between paying wholesale and retail prices for the management fees.
And, an employer's plan is generally a "safer" option than an IRA, especially for novice investors. There is simply a lot less than can go wrong by investing in the funds offered by your company's plan, as opposed to attempting to pick individual stocks when you don't really know what you're doing. In your company's plan, you'll be invested in relatively low-risk funds which are managed by people with years of expertise in investing.
And, with a 401(k), you get access to excellent sources of professional financial planning advice that can help point less-savvy investors in the right direction in their investing endeavors. Depending on your specific plan, you could still have access to this advice even after you leave the company.
It is also worth mentioning that if you were at the job for a relatively short amount of time and have a small (less than $5,000) balance in your 401(k), the employer isn't required to let you keep your money in the plan. So, if this applies to you, make sure staying in the plan is an option before you begin to weigh the pros and cons.
Taking control of your own destiny
If you haven't figured it out yet, this is by far my favorite of the three options. To sum it up, rolling your 401(k) into an IRA gives you much more control over your investments.
Don't want to pay fees? Pick your own stocks and you won't have to. Do you have a little more risk tolerance than your employer's mutual funds can accommodate? No problem, with an IRA you are free to choose any stock, bond, or fund you want to invest in. Many brokerages will even let you use certain options strategies and trade futures if you so choose.
Rolling over is an especially good idea if you have more than one old 401(k), since you can consolidate your retirement savings in one place.
So what's right for you?
Look, if you enjoy a hands-off approach to investing and believe your only role should be to let your money grow, it is perfectly fine to leave your 401(k) alone. And, there is absolutely nothing wrong with it if you feel that way.
However, if you believe (as I do) that you can do better than the relatively conservative investment funds offered by most 401(k) plans, enjoy investing, and want to have more control over your financial future, rolling over your accounts to an IRA is the clear choice.
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