This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Wednesday, September 12, 2007

What happens to your 401k when you leave?

Posted By Paul

I had someone ask me recently what to do with their 401k when they leave a job. I thought I'd take a moment and list the options and my opinion on each:

Option 1: Cash it out.

This means just that, you take your money out of your 401k and get a check and it's yours to do with as you please. DO NOT DO THIS! When you cash out your 401k you get taxed on it, which really defeats the purpose of why you put the money in there in the first place. There may be a situation where doing this makes sense, but it would have to be a VERY extreme and dire situation before you start considering this.

Option 2: Leave it there.

As far as I know all 401k plans let you leave it in your company plan even if you are no longer an employee there (I think a lot of places have minimum balances you have to meet before you can do this, but usually they're pretty small). This option is fine, especially if you really like the 401k plan at the company you left. However, it also means that your 401k is in a company plan that you're sort of out of the loop on. Since you don't work there you don't get the nice annual presentation on the 401k program, and there may be other inconveniences. Generally I don't think this is all that great of a choice.

Option 3: Roll it into your new company 401k.

After leaving your old job you will probably end up at a company in the future that has a 401k plan of its own. You can then just roll the money from one to the other. It's a pretty simple process that takes a little bit of paper work, but your benefits representative at the company can help you with this as it is VERY common. I usually do this when I switch jobs but once I did try option 4.

Option 4: Roll it into your own IRA.

You can just open up an IRA and roll the money into that. Where you manage it yourself. When I did this one think I liked about it was that I rolled the money into my IRA and then any new money went into my new company 401k, so I haven't made any contribution to that IRA for several years now. It's kind of cool because I can actually watch and see how well my investment is doing. That's sort of harder with a 401k since you're constantly putting more money into it, but with my IRA I can easily tell you what percent increase I made in the last year, which is nice.

These are the only 4 options that I can think of. I think most people go with option 3 when they switch jobs, which I think makes sense. As long as you don't cash it out then I think any of the other choices is fine.

1 comment:

Kevin said...

Another point about option 1 is that there is a 10% penalty associated with it unless someone is at retirement age. This penalty is in addition to the taxes you are subject to due to the option 1 "windfall". Some employers will withhold some your funds in order to "help" you pay your tax bill at the end of the year, but I have read of several people who were startled by the size of their tax bill after exercising option 1. Assuming that I am in the 28% federal tax bracket and I have a 9% state income (i.e., Oregon), I would be paying nearly half of my “windfall” in taxes and penalties. I would consider any investment of mine that lost nearly half of its value as a bad investment. I can strongly agree with your point that this option is a BAD IDEA.