Ah, a new job. A fresh start. New projects to tackle, a new office kitchen to navigate, and new co-workers to learn about.
In all the excitement that comes with a new employer, it can be easy to forget a nagging piece of your past life yet unresolved: your old employee retirement account.
Hopefully, when you change companies, you have some money stashed away in the 401k through your old employer. Amidst the hustle and bustle of your shiny new life, a fleeting thought makes its way across your consciousness: “What do I do with my old retirement accounts?”
Cash it out? Leave it there? Roll it over into an independent retirement account (IRA)? Here’s why a 401k rollover to an IRA makes sense.
Why you shouldn’t cash out your 401k
It might be tempting to think about cashing out when you move on. After all, it’s your money. Why not use it for something good now?
By opening a 401k, you agreed to let the money grow until retirement. It’s a win for you and for the brokerage. You’re contributing to their growth, and you’re earning the benefits of compounding interest over a lifetime.
If you break this agreement and pull the money out before you turn 59 ½, there is a 10 percent federal tax penalty. You’ll also have to pay regular income taxes on the money.
Compound interest snowball for the win
Apart from this, cashing out early means you miss out on compounding interest. The sooner you start investing, the more your money will compound over time and the more you’ll have in retirement.
Here’s an illustration of the power of compounding interest. If you were to save $5,000 a year from age 25 to age 35, you could have $60,000 more by retirement than if you were to save $5,000 a year from age 35 to 65!
The more time you give your retirement savings to snowball, the better. Don’t feel discouraged if you didn’t start saving into your 401k at 25. As the ancient adage goes,
“The best time to plant a tree was 20 years ago. The second best time is today.”
So, don’t regret yesterday, but don’t make the mistake of losing the momentum your retirement savings is building up by taking it out early.
To leave it alone, or do an IRA rollover?
Once you’ve moved on to a new employer, you can’t contribute to your old employer’s 401k anymore. This means that any growth will have to come from what was in the old 401k when you left. If you want to keep adding to your retirement wealth (as you should), you’ll need to move the funds to an IRA.
It might be tempting to ignore the old 401k and let it do its thing in the backdrop of your financial life. But there are some potential issues with doing so, and often no real benefits. It could make things more difficult in the long run.
Loss of profits with passively managed 401k funds
Many 401k plans have 1 percent to 1.5 percent fees. Over time, those percentages cut into the money you’re earning in the market.
Consumer Reports illustrates it this way: if you invest $10,000 into a 6 percent gross return fund with a 1 percent expense fee, you’ll have $25,000 in 20 years. But if you invest that $10,000 into a fund with the same return, but just a 0.20 percent fee, you’ll have $29,000 in 20 years.
Different 401k accounts might charge different fees, depending on the details. Administrative fees, investment fees, and management fees could all be in play. For an account that you can’t add to or change, that could be a big money leak.
Peace of mind now, ease of access later
Another reason to do a 401k rollover is the practicality of having your retirement savings consolidated. It’s easier to keep track of your asset allocation (how much money you have invested where) when it’s not spread across several firms from old jobs.
Come retirement age, you could overlook some long-forgotten 401k that’s now sizeable, or would just be handy to have. Consolidating your accounts can bring peace of mind and feel less scattered. It will also make withdrawing from your funds much easier and more straightforward when you retire.
401k rollover to IRA
Another reason to roll your 401k into an IRA is often getting a better selection of funds. With more options, you can select lower-fee investments and avoid some fees altogether.
Many IRAs don’t charge fees for opening or maintaining an account and any account service fees or maintenance fees can be eliminated by opting out of paper statements for your IRA.
With an IRA, you have more freedom to choose which investments you want to make. This can be a great way to optimize your portfolio by choosing funds you like, or funds you can’t get in other retirement accounts. It’s a smart way to make sure you’re diversified across a wide range of funds.
How to do an IRA rollover
If you decide a 401k rollover to an IRA is right for you, it’s a fairly simple process. Just be sure you request a direct rollover from your old 401k to your new IRA. This will ensure you’re not subject to any early withdrawal penalties or taxes. You don’t want a check made out to you.
IRA rollover fees are uncommon, but if there are any, it would be from the old 401k account you’re taking the money from. Ask your old 401k provider before you move the money.
Once your money is in your new IRA, you can start adding to it right away. So, you can settle into your new desk with a deeper feeling of being organized and confident.