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What to do with an old 401(k)

Retire

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You left the job years ago but never dealt with the break up – what are you supposed to do with the savings in your old 401(k) now? The answer to this question will vary for everyone. Furthermore, recent Bureau of Labor statistics show the average person will change jobs between 10 and 15 times throughout their career, so it will become increasingly important for you to know how to answer it.1
 

Below we explore four potential options you may have, as well as what considerations should go into deciding which option is right for you.

Options for What to Do with Your Old 401(k):

1. Keep It Where It Is

This is the simplest option – do nothing. Most plans allow you to leave the money right where it is as long as your balance is above a certain level, typically $5,000 but it varies plan to plan. While keeping it where it is may seem like an act of laziness, there may be benefits to keeping your savings in an old employer plan.
 

For starters, your savings will remain invested and continue to have the potential to grow, plus any growth will continue to be tax deferred. Additionally, you may find the investment menu offered in the plan or any other features of the plan you may be taking advantage of, such as automated advice, are better than if you were to move the account somewhere else. It’ll be important to review your current plan features and compare them to those in other accounts to help you make a decision whether it makes sense to keep your money where it is. 
 

One other feature of remaining in-plan that many people see as a benefit is that most 401(k)s allow you to borrow against them, i.e. take a loan from them. While it’s not ideal to dip into your retirement savings, if you are in need of cash, it’s not always a bad option. Taking a loan from a 401(k) isn’t a taxable event, but keep in mind when you pay back that loan, it is made with after-tax money. And if you do not pay back your loan, then it is a taxable event and taxed like a retirement distribution – including a penalty if younger than 59 ½. Loans from a 401(k) also usually have relatively low interest rates and as you pay back that interest, the money goes into your account, not to the lender (because you’re essentially your own lender). This type of loan also doesn’t require a credit check, so it won’t go on your credit report or affect your credit score. Before taking a loan from your 401k, be sure to understand your plan rules around loans and the potential tax consequences of taking one.
 

If you have changed jobs a few times, or just prefer to have all your money in one place, consolidating your retirement assets into one or as few accounts as possible is sometimes worth the peace of mind. Keep reading for options to consolidate your old employer plan now that you’ve moved on.

 

PROS CONS

Defers current taxation

You cannot make additional contributions if you stay in your old employer’s plan, and there may be different rules for inactive employees

Your money can continue to grow tax deferred

You will be subject to the distribution options under the plan

You may be able to take penalty-free withdrawals after age 55

Your investment options will be determined by the employer’s plan

You may have access to loans and hardship withdrawals

Future changes to a plan may change the process for accessing your money

2. Rollover into Your New Employer Plan

While keeping your plan where it is may be an easy option and, in some cases, a beneficial one, it may make life easier down the road if you consolidate your old 401(k) accounts by rolling them into your current one, if the plan allows. You’ll have fewer portfolios to manage at fewer institutions. The other benefits of this option overlap with the benefits that come with keeping your money in an old plan (mainly, that your savings can remain invested, continue to grow tax deferred, and you’re allowed to take a loan from them). Assuming your new plan allows you to roll over savings from another employer account (most do), you may have the option to do a direct rollover or indirect rollover.
 

With a direct rollover, your money is transferred directly from the old plan into your new one, so you never have it in your own hands. With an indirect rollover, you withdraw the savings in your old plan and receive a check made out to you and then are responsible for re-investing the funds in your new plan on your own. The catch is that the IRS will withhold 20% from the amount for income taxes, since the money is going into your hands. As long as you move the full amount of your rollover money into your new plan within 60-days however, you’ll be refunded what they withheld when you do your taxes. But keep in mind to do this, you will need to use your own after-tax money to make up the difference.
 

Here’s an example: if you’re doing an indirect rollover of $10,000 and the IRS withholds 20%, you’ll have to find the $2,000 they withheld from your own money to contribute into your new plan to complete the $10,000 rollover. When you do, that refund of the $2,000 will come when you file your taxes. For this reason, indirect rollovers are less popular and more complicated than direct rollovers and will require more work and responsibility from you.
 

PROS CONS

Defers current taxation

You will be subject to the distribution options under the plan

Your money can continue to grow tax deferred

Your investment options will be determined by the employer’s plan

You may be able to take penalty-free withdrawals after age 55

 

You may have access to loans and hardship withdrawals

 

You may be able to make additional contributions under your new employer’s plan and receive employer matching contributions if eligible

 

3. Rollover into an Individual Retirement Account (IRA)

If you don’t want to rollover an old plan into your new employer plan (or don’t have a new plan to rollover into), but you don’t want to simply leave your money sitting in your old plan either, you should consider setting up a rollover Individual Retirement Account (IRA). This can be done at any institution of your choice and like rolling into a new employer plan, it can be done directly or indirectly. Like with consolidating your accounts in your new employer plan, moving your funds to an IRA allows you to remain invested and allow your money to grow tax deferred.
 

Depending on the firm and account type you choose to rollover into for your new IRA, your investment options and fee structures can look a lot different. For example, in your new IRA you may have access to a wider range of investments, including individual stocks and ETFs, but you may not have access to potentially cheaper share classes that you had in your old plan or investment options like a stable value fund. You’ll also want to look at the features associated with the IRA compared to your old 401(k), such as investment guidance or access to online trading capabilities, if those things are important to you.
 

PROS CONS

Defers current taxation

Withdrawals made prior to age 59½ may be subject to a 10% IRS early withdrawal penalty and will be subject to ordinary income tax; state and local taxes may also apply.

Your money can continue to grow tax deferred

You cannot take a loan from your IRA    

You can make additional contributions

No employer matching    

You can consolidate multiple tax-deferred accounts

Fees and expenses could potentially be higher than in a plan

You may be able to take penalty-free withdrawals for a first-time home purchase or college education expenses prior to age 59½    

 

4. Cash Out

The last option is to simply withdraw the money in cash and close the account. Don’t let the word “simply” fool you, though. Unless you’re age 59½ or older, this is not an advisable option. If you are age 59 ½ or younger you will be charged a 10% early withdrawal penalty fee, plus regardless of your age, you will have to pay income taxes on the full amount withdrawn. You may even wind up in a higher tax bracket for the extra income that year. Cashing out is a costly option and should only be considered in cases of extreme hardship. You should always consult a professional and make sure you fully understand the repercussions of this option before deciding to do so. 
 

PROS CONS

Immediate access to your money (once the distribution is processed and applicable taxes and possible penalties are withheld)

Your cash distribution will be subject to a potential 20% federal income tax withholding and possibly additional federal, state and local income taxes come tax time

You can still roll over all or a portion of your money without any tax consequences if you do so within 60 days of taking a distribution    

Your cash distribution may be subject to a 10% IRS early withdrawal penalty if taken prior to age 59½    

Favorable tax treatment may be available to individuals born before 1936 who take lump-sum distributions    

By taking a cash distribution and not investing the proceeds, you may be limiting the potential growth of your retirement assets

Other Considerations:

Below are different factors you should always consider and make sure you've done your homework on when deciding what to do with your old 401(k). 
 

Fees: Whether you choose to stay in your former employer’s plan or decide to rollover into a new employer plan or an IRA, do some homework about fees. Consider the costs of the investments offered within an account, as well as trading costs and any fees associated with the account (some may charge a quarterly or annual fee).}
 

Breadth and Quality of Investments: Fees are just one thing to look at when considering what investment options are available. If you consider yourself a pretty savvy investor, you can compare your new employer’s investment menu to your former, or if you are thinking of an IRA, pay attention to what different investment vehicles they offer. If you’re new to investing, talk to a professional who can give you guidance on this matter.
 

Services and Account Features: Different accounts can come with different features and offerings. For example, many 401(k) plans will come with advice services, either free or fee-based. If you prefer to take a hands-off approach to investing, look for a managed account solution which is sometimes an option in different plans and IRAs.
 

Liquidity: While it’s generally not ideal to dip into your retirement savings, life sometimes happens and different options of accessing your money, and any penalties, will differ between accounts. Pay attention to the rules for withdrawing funds in case you’re ever in need of liquidity.
 

Taxes: It’s important to understand the tax implications associated with the different options for what to do with your 401(k). For example, if you choose to cash out, you may end-up in a higher tax bracket for the year and have to pay significantly more in income taxes. 

 

Understanding your options, including the possible advantages and disadvantages of each, can help you make an educated decision about what to do with any old 401(k) plans you may still be holding on to. If you need guidance, the financial planners at John Hancock can help you determine which option is best for you and will keep you on track to achieve your retirement savings goals. They can also help facilitate a rollover if you’re interested in establishing an account at John Hancock. Take charge of your future – do your homework and make an informed decision that is right for you.




Citations:

1  https://www.thebalancecareers.com/how-often-do-people-change-jobs-2060467


Please note: Financial advice should be tailored to individual circumstances and the content of this article should not be viewed as recommendations. This article is not an endorsement of any particular product, service or organization; nor is it intended to provide financial, tax or legal advice. It is intended to promote awareness and is for educational purposes only. The specific applications and services noted are not necessarily endorsed by John Hancock or any of its affiliated businesses.


Advisory services offered through John Hancock Personal Financial Services, LLC, an SEC Registered Investment Adviser. Boston, MA 02116. 888-955-5432.


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