4 Risks of Leaving Money in an Old 401(k) Plan

When you left your last job, you may have forgotten something: your money. No, not the coins in your desk drawer. The retirement plan money in your 401(k).

What happens to your 401(k) accounts when you quit or leave your job? Many people leave their money in a former employer's retirement plan simply because they don't know they can move it elsewhere. They may not know they have other options, such as rollovers to new accounts.

You may be eligible to leave assets in the 401(k) plan if the vested balance (the amount you can take with you if you leave your job) is more than $7,000.

What if your vested balance is less than $7,000? If you fail to make an election to receive a distribution or to roll it over to an IRA (Individual Retirement Account) or a new employer’s plan, your old employer can automatically transfer your balance to an IRA provider chosen by your old employer, or cash it out (depending upon the plan’s provisions).

Your 401(k) accounts could be the largest sum of money you’ve ever accumulated, so making the right choice for your future is essential. Leaving money with your old employer means you can’t save additional funds in that account and may face limits on how you can invest.

Change jobs every few years? If you roll over, you can avoid having multiple 401(k)s scattered among your old employers.

Leaving Your 401(k) Money: The Risks of the Easy Way

Staying in your old 401(k) plan may be the easiest option. Your assets will continue to grow tax-deferred, and you may not incur the same fees, expenses or penalties as when you move your money or cash it out. But consider this:

1. Your Former Employer Is in Control of Plan Rules

If you leave your old 401(k) account behind when you leave your job, your retirement money is still subject to the rules set by your former employer. They can make changes to plan administration and recordkeeping and to your investment options. The plan may add restrictions on changing investments or impose limits on how often you can withdraw money.

Your 401(k) provider’s fees also may be high, reducing your investment return and leaving you with less money for retirement. Additionally, your old employer can change the investment options available in the plan, and those new options may not be ideal for your personal circumstances.

2. Old Plan, New Needs

If your job has changed or you have retired, chances are your financial goals have shifted as well. You may need to reevaluate your old plan to ensure it still aligns with your future goals. And even if you decide to keep the money in place, you won’t be able to make additional contributions to the account as a former employee.

3. Missing the Big Picture

You may have overlooked old retirement plan money when creating your current investment strategy. If you previously invested in one type of asset (like stocks or bonds), you could face unnecessary risk by not being well diversified. When you begin saving for retirement in your new job’s plan, it may be difficult to determine your overall asset allocation across multiple retirement accounts.

4. Out of Sight, Out of Mind

Even with paper or electronic statements, losing track of an old account is a risk. That’s especially true if you only check it once or twice a year. This makes it difficult to know how the investment (and your overall portfolio) is performing. You also risk forgetting about your money entirely.

Ready to Roll? IRA Rollover Options and Benefits

One common alternative is to roll your money into an IRA with a company you choose. These rollover IRAs put you in the driver’s seat: You decide which company to invest with and which investment options and asset types work best for your goals. Consolidating your retirement savings with one provider can also make recordkeeping easier.

Employer retirement plans, including 401(k), 403(b) and 457 plans, are eligible for rollover to an IRA when you leave or retire from a job. You may also have the option to add to your IRA with additional contributions and make rollovers from other former employer retirement plans—thus consolidating all of your retirement money into one account. You can also move money from a former employer’s plan to your new employer’s plan later if allowed.¹ If you max out your retirement savings in your new employer’s 401(k), an IRA can allow you to save even more money.

If you saved through a Roth 401(k) at your old job, which could provide tax-free withdrawals in retirement, you can transfer those funds to a Roth IRA. That transfer is not a taxable event.

IRA accounts can also provide tax benefits. Some or all of your contributions to a traditional IRA may be tax-deductible. Income tax on earnings is deferred until you withdraw them. With a Roth IRA, contributions are not tax-deductible but can be withdrawn tax-free and penalty-free at any time. Earnings can be tax-free if the account is at least five years old and you are 59½ or older.

There are no tax penalties for rolling over money, but some companies could charge more in account fees or expenses than if you leave the money in your old plan.

How To Do a Rollover After Leaving a Job

There are different types of rollovers, whether to an IRA or to a retirement plan at your new job.

With a “direct rollover,” your former employer retirement plan funds will transfer directly to the financial firm where you’ve opened your new IRA or to the recordkeeper/trustee for your new employer’s plan.

With an “indirect rollover,” your old company’s 401(k) plan provider will issue you a check to distribute your retirement funds directly to you—minus 20% mandatory withholding. You then must move the money into an IRA or your new job’s retirement plan within a 60-day time period; however, you have to come up with the 20% that was withheld from the distribution. You face an early withdrawal penalty if you do not deposit the entire amount within 60 days.

Due to the potentially significant tax consequences of indirect rollovers, we encourage you to speak with a tax advisor before considering that choice.

The Pitfalls of Cashing Out Your 401(k) Plan Accounts

Is retirement many years away? You may be tempted to cash out your retirement plan accounts. Though cashing out is the quickest way to access your money, income taxes, a 10% federal penalty tax and state taxes could significantly reduce the amount you’ll receive if you are younger than 59½.

Cashing out a 401(k) account may leave you with just a portion of your money. For example, a cash withdrawal of $100,000 from a 401(k) before age 59½ incurs the following reductions:

• An immediate reduction of $20,000 in mandatory 20% federal tax withholding at the time of the distribution (which is remitted to the IRS as a credit toward your income taxes due on the $100,000 distribution).

• $8,000 in potential state and local income taxes, paid when you file your income taxes for the calendar year you took the distribution.

• $10,000 as an IRS-imposed 10% early withdrawal penalty, paid when you file your income taxes for the calendar year you took the distribution.

In addition to taxes and penalties, cashing out means you sacrifice the potential future growth of your money. For example, the 10% early withdrawal penalty amount of $10,000 invested for 30 years could grow to $57,435.²

Managing Your 401(k) Accounts After You Leave Your Job

Starting a new job can be a hectic time, but don’t forget the 401(k) accounts from your old job. Carefully weighing your options, such as leaving the money behind, rolling it over or cashing it out, can help ensure you make the best choice for your financial situation.