Changing jobs can be a scary thing. It’s hard to leave what you know for the potential opportunity, and downside, of the unknown of changing companies. Chances are that if you’re looking it’s because you’re unhappy with some aspect of your current situation and are willing to take the gamble, but I have good news – I am here to take one thing off your plate and tell you what you should do with your 401K from a previous employer.
The good news that I have for you is no, you will not lose your 401K. You’ve contributed money to it and your company might’ve contributed some funds as well as part of a match or bonus, and you will get to keep that money – but that doesn’t mean that things won’t change for you.
Fortunately, I have never had to change employers and still gotten to experience many different jobs with my one employer throughout my 7 years of working after college. My wife, however, has changed jobs multiple times so I have gotten to see how she has dealt with this situation firsthand.
Good news, again – it’s really not that hard.
You have quite a few different options with that old 401K, and while it might seem really complicated, it’s really not when you sit down and think about it logically.
Basically, you can do 3 things:
1 – Do Nothing
You can choose to do absolutely nothing if you want to and just let the money sit there. If you’re a natural procrastinator (like me) then you might stop reading at this point and opt for this option, but don’t.
Let me be clear – I think this is an awful option to do nothing.
The only positive of doing nothing is that you get to do nothing. Unfortunately, there are many negatives that you might have to deal with.
If your account balance is under $5K, your former employer might just choose to cut you a check and basically kick you out of the plan. At that point your hand is being forced to put that money into a different account within 60 days or just keep the money.
If you keep the money, you’re going to owe any applicable fees and a 10% penalty for early withdrawal. AKA – don’t keep the money.
If you have over $5K, then you can let your money sit but be careful – the company that is managing your 401K might start charging you higher fees.
It’s not necessarily that they’re charging more, but your employer now isn’t covering any sort of those costs so they all fall on you.
You left your employer – why would they let you keep sitting in their company 401K and paying for you? I sure wouldn’t!
Fees can absolutely kill your returns if you’re not careful. They’re something that you really, really need to keep a close eye on, especially when there are so many options for essentially no-fee ETFs. Fidelity, among others, offer 0% commission on their trades and ETFs, so I really recommend making sure you’re minimizing those as much as possible.
Even a 1% charge might not seem like a huge difference but it is. Imagine the following:
You make $50K/year for 30 years. You contribute 5% of your income and your employer matches that. You earn 8%/year in the market as a conservative estimate.
You would then have $611,729.
Now, imagine the same situation but you pay 1% in fees – you now have $505,365.
So, while it’s just a 1% fee, in total you lost over $106K and it brought your total return down from 208% to 137%, or about 1/3 less than if you’d avoided this fee.
See what I mean? Fees are DEADLY, even if they seem small and miniscule.
In addition to the fees increasing, you might just simply forget that you even have this 401K. Maybe it’s very small and from a job that you had fresh out of college. You move on to go work for a different company with that you love and end up retiring with that company.
You might just completely forget that you even have this 401K.
“Oh well, I only worked for that company for 1 year, so it’s only like 5 grand even with those fees.”
Maybe you only put 5 grand in – but it’s not that now:
As you can see, the power of compound interest is strong as your $5K has nearly reached 8X that simply by it just sitting there – not too shabby!
But you very well could completely forget about it if you keep it where it is.
So, honestly, just don’t let your money sit. There are tons of reasons why you shouldn’t leave it and there are even more reasons why you should move it!
2 – Move it to a Different Retirement Account
This is by far my preferred option for what you should do. If you move it into a different retirement account then you can avoid having to pay taxes and any fees, as long as you move it within 60 days of when you cash it out.
As I mentioned before, my wife switched jobs and her new employer offered a 401K with Fidelity. She simply just reached out to Fidelity and they told her exactly what she needed to provide and then they did the rest for her.
The process was extremely simple on her end.
Think about it – you’re calling a different brokerage company and basically saying, “hey, I have some money that I want to give to you to hold onto instead of this other brokerage company – can you help?”
They’re going to be chomping at the bit to get more funds into their firm and will do anything they can to assist. Now, I am a huge Fidelity fanboy but I would be willing to bet most brokerage firms will act the same exact way that they do.
So, step 1 is to just reach out to the firm where you want the money to go.
But that’s not the only decision you have to make – you need to decide what sort of account you want the money to go into!
Personally, I am a big fan of the IRA option because of the increased flexibility that you have to invest your money the way that you want to.
With my 401K, I completely manage it on my own but I still only have a certain amount of funds that I can pick to invest in. Basically, there’s like 25 different funds with various allocations that track different indexes, have different market cap limitations, operate in different markets, or some other distinguishing factor.
Or, I can invest in a target date fund which I absolutely hate because they are going to have bonds in them.
Ok – quick little tangent…
I am 30 years old. I want to have 0 bonds. The only reason that I am ok with having no bonds is because I’m not allowed to have negative!
I used to have my 401K managed by Fidelity because I felt it was another layer of protection for myself to have someone else manage some of my assets, but they refused to take me out of bonds so I had to take over.
When I asked them to do it, they literally said that the reason was to protect me from the market crashing. Well, that makes sense, obviously, but then they said that when COVID really hit they put me into even more bonds…
So, they basically had me in stocks, waited for the market to crash, moved into bonds, and then missed the rebound. Sweet.
I’ll take it from here. But that’s why you don’t try to time the market, even if you’re a professional! It’s one thing to put a rainy-day fund to work to try to capitalize on a discounted market – it’s another thing to completely change your asset allocation!
If you’re dead set on using the target date fund, pick something that is 10 years past your retirement to make it a little riskier. So, if I wanted to retire in 2050, I would pick 2060, meaning that the fund will ratchet down to a higher bonds allocation at a little slower pace than normal. Again, this is just my opinion from someone that has a pretty strong risk appetite.
For this reason, I like the IRA. I am not forced into funds that I don’t want to be in. I can buy literally any stock or ETF that I want and I don’t have to worry about being confined in the walls of a 401K. I can put 100% in Apple, 100% into cash, 100% into Tesla, or 100% into shorting the VIX. All of these would be awful decisions to make, but you get what I am saying!
Either way, regardless of if you choose to move your money into an IRA or a 401K, you’re making the right decision to move it from a retirement account to a different retirement account.
Doing this is going to allow you to avoid any sort of early-withdrawal fees and keep that money in the market and compounding!
If you’re out of work completely and looking to just move your money into a new retirement account, it might be a good time to consider a backdoor Roth. You can convert some of your pre-tax money, or Traditional Contributions, into a Roth account.
So, you’ll pay the tax now but then save an absolute ton on the backend. Before doing something like this, I highly recommend you talk to someone at your brokerage firm and read a little more on the Backdoor Roth, and even the Mega Backdoor Roth, as they are pretty complicated concepts.
3 – Cash it Out!
The last thing that you can do, and by far the worst option, is to just cash out the 401K.
Now, this might be the most intriguing option, especially if the balance is low and seems meaningless, but you’re going to not only pay taxes but also massive fees.
I know that it can be tempting to do this and use these funds as a down payment on a house, a way to furnish your new home, pay off a car loan, or anything else, but don’t!
Like I said, you’re paying taxes AND the 10% fee. It is just an awful decision to do this. Before you know it, you’re likely going to be looking at an amount that’s around 60% of the balance that you had in your account at the beginning.
If you had $5K, it’s now only $3K in your pocket. Seems a little bit less exciting, right?
Take a look at an example below from Fidelity when a 401K with $50K is cashed out instead of rolled over:
Your $50K just turned into less than $30K, or just under 60%. That is just so incredibly depressing.
Just do yourself a favor and don’t cash it out. Let the money sit in there and just keep compounding. You’re going to be very happy that this was the decision that you made when you retire sooner than expected.
So, there you have it – those are the three options you really have for your 401K when you leave your current employer.
Something else that I want to note is that it’s important to just reach out to your 401K provider prior to leaving your job. Make sure you fully understand any potential pitfalls that might be out there.
For instance, if you took a 401K loan out, you’re likely going to owe the entire balance as soon as you leave the company. So, that $5K loan that you’re paying $100 on every paycheck – yep, you owe the entire balance.
The $100 payments are now a thing of the past. You terminated your employment and also that payback aspect of the loan agreement, so you better have that cash handy.
At the end of the day, just make sure you’re prepared and have done your research. Talk to the HR departments of your old and new employer. Find out where the new 401K might be and even if you don’t want to roll it into that 401K, maybe you open an IRA with the same brokerage firm to keep in top of mind.
It’s just planning – that’s all. A few calls and you’re going to be well on your way.
In addition to getting this 401K into the right spot going forward, please make sure that you’re also maxing out your employer match when you start your new job.
If you don’t believe me, check it out with this free 401K Employer Match Calculator!