Accepting a new job is exciting. It’s also stressful, no matter how junior or senior you are in a company or organization. Even doctors, lawyers, and CPAs moving to a different medical, legal, or accounting practice face that stress – forming relationships with new colleagues, establishing new routines, and learning how things are done in the new place. In addition to making all your new benefit elections, you must decide what to do with your old employer’s 401(k) Plan assets. For this purpose, the term 401(k) will be a proxy used throughout this article to encompass other similar retirement plans, such as 403(b)s, Simple IRAs, 401(a)s, 457s, etc. In a nutshell, you have three options:
Leave things in the old employer’s plan if you can (some plans have automatic rollover or provisions that force you out if you have less than a certain amount in the account);
Move your 401(k) assets to your new employer’s 401(k) Plan (assuming one is available, of course). Again, with few rare exceptions, this is allowable and can be done without much hassle;
Roll the assets into a Traditional IRA (Individual Retirement Account) or a Roth IRA if you have after-tax dollars in the plan.
This could be a brief article, as we could simply say, “Choose #3,” and leave it at that. In fact, as a general rule, #3 usually is the best choice. Just be sure that you compare fees and the range of investment options before making a decision. However, there are exceptions — especially for those with high incomes, as we will discuss shortly. Note that we did not list a possible fourth choice, which may have occurred to you: take the money out of the old employer’s 401(k) Plan and use it to buy stuff. We did not list that as a choice because it is a terrible idea. If you are under age 59 ½, you would owe taxes and penalties that could eat up 40% of those savings and deplete your retirement nest egg. Therefore, we do not consider it to be a real choice.
Why Rolling Your “Old” f(k) into an IRA Makes Sense
Before we look at exceptions to the general rule of “roll old 401(k) assets into a Traditional (or Roth IRA if post-tax money is invested),” let’s look at why that is usually the best course of action.
Flexibility. As we discussed here, your retirement savings plan may represent much of your total savings, and flexibility matters when investing that money. But 401(k) Plans have a limited menu of investment options. That applies to the Plan at the organization you are leaving and the Plan at your new job. Even if a Plan offers a “brokerage window” that allows you to go outside the limited fund menu, that usually involves a per-transaction fee and other limitations. In contrast, you can hold virtually any stock, bond, mutual fund, or ETF in a Traditional IRA.
Fees. The limited menu of funds available through a 401(k) Plan often includes funds that charge high fees; make sure to look at each fund’s expense ratio. They can be a big drag on the returns you earn, and chances are you can find a similar fund with lower fees to hold in an IRA.
Roth 401(k) to Roth IRA. If some of your “old” 401(k) money is in a Roth 401(k), when you separate from your old employer, you can roll that portion directly into a Roth IRA. It is easy to do, and you can enjoy that greater investment flexibility and lower fees on your Roth account well into your retirement.
When you move assets from a previous employer’s 401(k) Plan to a Traditional IRA, it is imperative that the assets go directly from your previous employer’s Plan to your IRA account or at least get put back into a qualified retirement plan within 60 days. Unfortunately, each plan administrator seems to have different procedures, and some will only mail you a check. Direct rollovers are best, but if the rollover needs to be done indirectly, the IRS needs to see the offsetting contribution in your account paperwork. If not, they assume you simply made a 401(k) withdrawal subject to income tax and penalties. So, rolling 401(k) Plan assets from your previous employer to a Traditional IRA makes sense for most people. But just because something applies to “most people” does not mean it applies to you. Your set of circumstances is uniquely yours – and fees and investment options do vary from plan to plan or from one institution to another. It is important to compare the costs and choices of various options, as well as your personal situation, including your age, your tax bracket, your current income, your children and their finances, the value and income-producing potential of your other assets, and the liquidity of your assets, to name just a few considerations. In other words, the decision is not an automatic slam dunk, and a qualified financial advisor can add real value by analyzing the alternatives based on your specific situation.
Exceptions To The Rule
While rolling 401(k) assets to an IRA is more common, there may be times when it makes sense to do the reverse and roll your “old” Traditional/Rollover IRA money into your new 401(k). If your income (measured as your Modified Adjusted Gross Income on your tax return) is above the threshold that allows you to contribute to a Roth IRA directly, you can use what is known as a “Backdoor Roth IRA” to get money into a Roth account anyway. To do this (which is perfectly fine in the eyes of both Congress and the IRS), despite the name that sounds a bit shady) in a way that makes sense financially, you must “zero out” any Traditional IRAs you currently have. You can do that by rolling money from your IRAs into your new employer’s 401(k). You can then make a new contribution into the empty IRA with “after-tax” money (such as money from your paycheck that has already been taxed) and subsequently transfer/convert that Traditional IRA into a Roth IRA without any tax implications. There are also exceptions to the rule about rolling over 401(k) assets from an old employer’s plan to a new plan. For example:
If your new employer’s Plan options are limited and have high expense ratios (the funds charge high management fees) and your old employer’s Plan has a lot of great options, it’s not a terrible idea to keep your assets in the old Plan.
If your old Plan allows for in-plan Roth Conversions (and your new one doesn’t), you could use this to your advantage. The idea with a Roth conversion is to move some or all of your “pre-tax money” into a “post-tax” Roth account. This will create additional ordinary income taxes now! Yet, depending on your situation, it could be cheaper than paying taxes in the future. Again, your own specific circumstances come into play in making these decisions. For example, if you are going to have a lower income year for some reason, converting what you can now to a Roth reduces future required minimum distributions from the 401(k) and potentially keep you in lower tax brackets, especially when withdrawing pre-tax 401(k)/IRA money throughout retirement. Your financial advisor can analyze and present the key variables to you.
Apart from deciding what to do with the assets in your old employer’s 401(k) Plan, it makes sense to contribute to the 401(k) Plan in your new job up to the maximum amount required to get the maximum matching contribution from your employer. If the Plan offers a Roth 401(k) option, it could make sense to contribute the maximum amount allowed that way unless you are in a high tax bracket. Again, a qualified financial advisor should be able to coach you on the best course of action, given your individual situation.
What about SECURE 2.0
The SECURE 2.0 Act passed in 2022 is designed to increase retirement savings. Many things in SECURE 2.0 are beyond the scope of this article, but most of the provisions do not take effect until 2024, so there is time to learn more. We mention a few items: Starting in 2024,
Retirees will no longer be required to take minimum distributions from a Roth 401(k). Even though the withdrawals were not taxed, that was an inconvenience and gave people another incentive to roll a Roth 401(k) into a Roth IRA. Now neither type of Roth is subject to minimum distributions – good job, government!
If you are over 50, you can make a catch-up contribution to a 401(k), currently up to $6,500 annually. Under SECURE 2.0, catch-up contributions must be designated as Roth contributions for any plan participant whose wages exceed $145,000.
Employers can make matching and non-elective contributions to a Roth 401(k) account.
To summarize, if you are seriously considering moving to a new job, you’ll want to make the best choice for your 401(k) Plan assets. The best option may seem obvious, but there are always extenuating circumstances. Talking things over with your financial advisor could save you money and give you peace of mind in analyzing this and handling the details. That’s a good way to start the next chapter in your career.
Disclosures:
The taxable portion of your 401(k) withdrawal that is eligible for rollover into an individual retirement account (IRA) or another employer's retirement plan is subject to 20% mandatory federal income tax withholding, unless it is directly rolled over to an IRA or another employer plan. (You may owe more or less when you file your income taxes.) If you are under age 59½, the taxable portion of your withdrawal may also be subject to a 10% early withdrawal penalty, unless you qualify for an exception to this rule. Be sure you understand the tax consequences, legal protections from creditors and legal judgments, and your plan’s rules for distributions before you initiate a distribution. You may want to consult your tax advisor about your situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money. Be sure to consider all your available options and the applicable fees and features of each before moving your retirement assets. This information is not intended to be a substitute for specific individualized tax, legal or estate planning advice.
This post is for informational purposes only and is not intended to be a solicitation or substitute for individualized investment advice. Information provided is believed to be from reliable sources, but no liability is accepted for any inaccuracies. Past performance is no guarantee of future results. Advisory services offered through Gold Medal Waters, a Registered Investment Advisor.