If you're like most Americans, you're likely to change jobs several times over the course of your working life. This means you'll probably wind up with one or more 401(k) accounts from former employers.
When it comes to your old 401(k)s, there are four basic options you have to choose from. Here is an overview of your options, along with the pros and cons of each.
Option 1: Leave it alone
The easiest choice is to simply leave your old 401(k) account in your old employer's plan. And if you prefer to have a passive role in your retirement planning and are satisfied with the investments available in the plan, there's nothing wrong with this option.
Leaving your account alone makes sense for many people. For example, novice investors are probably better off leaving their accounts invested in the funds their 401(k)s offer, rather than rolling their accounts into individual retirement accounts and attempting to pick their own stocks. And even if you plan to investing in mutual funds, make sure you compare the fees involved. Your 401(k) may have good low-cost investment options that you cannot obtain in an IRA.
One other thing to bear in mind is that if your 401(k) has a relatively small balance (under $5,000), your employer is not required to let you keep your account in their plan.So if your balance is below the minimum, leaving your old 401(k) where it is may not be an option for you at all.
Option 2: Bring it with you
If you want a passive role in your retirement planning but simply want to consolidate your savings, you can usually roll your old 401(k) into your new employer's plan. Not all employers allow rollovers, so check with your plans' administrators about your particular rules. This is definitely my favorite of the two passive options, because it makes it easier to keep track of your savings, but the right choice for you depends on the particular 401(k) plans you are invested in.
When you start a new job, it's worth taking some time to educate yourself on the investment options available. If your old employer's plan has lower-cost options or a better record of performance, it can make sense to keep your old account where it is. If the options available in your new plan are comparable, I always suggest rolling the money over if you prefer not to take an active role in your retirement planning.
Option 3: Roll it over into an IRA
This is my personal favorite option for experienced investors. If you already invest through an IRA or brokerage account, you may want to consider rolling over your old 401(k) into an IRA account. This is generally an easy process, and many brokerages even offer cash incentives for rolling your 401(k) funds over into an account with them.
The main reason I prefer this method is that it gives you the most control over your own retirement planning; 401(k) plans are limited to the selection of funds the plan offers. However, in a rollover IRA you're free to invest in pretty much any stock, bond, or mutual fund that you want. Furthermore, while some 401(k)s offer certain investments for lower fees than you'd be charged elsewhere, other 401(k)s charge fees that are much higher than what you'd pay if you made smart picks in an IRA.
Again, if you don't know what you're doing, this probably isn't the best option, but a well-constructed portfolio of high-quality dividend growth stocks or even low-cost mutual funds and ETFs is an excellent way to create long-term wealth. At the Fool, we write extensively about the types of stocks that work well in retirement accounts, so articles like this one are a good place to start.
Option 4: Take the money and run
This is by far the worst option of the four, and it rarely makes sense for anyone. Not only is cashing out your 401(k) early expensive, but it can be devastating to your long-term retirement savings.
Let's say that you have $10,000 in your old 401(k) and you want to cash it out. Well, not only will you be taxed on the money in the account, but you'll most likely have to pay a 10% early-withdrawal penalty to the IRS. So, if you're in the 25% tax bracket, your $10,000 will turn into $6,500 or less (depending on what state you live in) by the time you get your check.
And more importantly, consider the impact that $10,000 could have on your long-term financial health. Sure, it doesn't seem like that much now, but you need to factor in the potential growth of that amount of money.
For example, if you are 35 and your account grows at an average rate of 8% per year (less than the S&P's historical return), that $10,000 401(k) could grow to more than $100,000 by the time you turn 65. Is it worth cutting your retirement savings by $100,000 to get a $6,500 check today? I don't think so.
So, what should you do?
The best move for you depends on how involved you want to be in your retirement planning and how much you like your old and new employers' 401(k) plans.
Again, there is absolutely nothing wrong with keeping your money in your old employer's plan or rolling into your new plan if you just want to sit back and let your money work for you. However, I firmly believe that learning a little about investing and taking more control of your own financial destiny can be well worth it in the long run.