Certified financial planner Sophia Bera answers:
What happens to my 401(k) when I change jobs?
Great question this week! You have a few different options of what you can do with your 401(k) when you switch jobs.
- You can leave it in your old employer's plan and do nothing.
- You can roll over the money into your new 401(k) plan.
- You can roll over the money into an IRA.
- You can roll over the money into a Roth IRA and pay taxes on the conversion.
- Cash out (make it rain!) and get hit with a 10% penalty, plus a boat-load of taxes. (Hint: Don't pick this one.)
A few things you should know: When you contribute to a 401(k), the employee contributions are kept separate from the employer contributions. Any money you contributed as the employee is 100% vested immediately (meaning it's yours to keep if/when you leave).
Sometimes employer contributions are 100% vested immediately and sometimes they have a "vesting schedule." Therefore, on your 401(k) it might show a "vested balance" which is the total amount you can move when you change jobs. This is to encourage employee retention.
Let's explore those five options further:
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1. You can leave it in your old employer's plan and do nothing.
This happens a lot.
Action takes effort and as humans, we tend to be lazy. By leaving your account with your previous employer, you're limited to the investment options that are in the plan, and you can often find less costly and more robust investment options if you open an IRA or Roth IRA and do a rollover.
This isn't the worst thing you can do, but you should check the fees you're paying to keep your account there — start by checking the expense ratio of the funds in the plan on Morningstar.
If the fees are more than .5% on each fund, I would recommend doing a rollover.
2. You can roll over the money into your new 401(k) plan.
One place you can roll over the funds is into your new employer's 401(k) plan.
Check the expense ratios of the fund choices in the plan first before you do this. If they're higher than an average of .5%, then I would roll over the funds to an IRA or Roth IRA instead.
Some people prefer the simplicity of having all their 401(k) money in one place. If the balance is fairly small (less than $10,000), then the fees have a small impact on your decision and you might favor simplicity.
Again, you'll be limited by the fund choices in your new employer's plan, so look into them before you roll over a big balance. You won't pay any taxes on the rollover or pay penalties from moving one 401(k) to another.
3. You can roll over the money into an IRA.
The most common recommendation that I make for clients is to roll over their old 401(k) into a new IRA.
There are many discount brokerage firms where you can set up an IRA but here are a few of my favorites: Vanguard, Schwab, Fidelity, and Betterment. (I have a relationship with Betterment Institutional, so that's where I manage my clients' assets).
Vanguard is known for having some of the lowest expense ratios on index funds and ETFs, but you'll need at least $3,000 to open a new account there (plus their website is clunky). Schwab and Fidelity both have a list of commission-free ETFs that I like because you don't have to pay a trade fee every time you buy one. (Schwab's list here, Fidelity's here.)
Betterment is my cup of tea for novice investors that want to keep things simple: They don't have a minimum to invest, their website is extremely user friendly, they use a lot of low-cost Vanguard and Schwab ETFs but they can buy fractional shares, and it's super easy to automate contributions.
Again, there's no tax implication to roll over a 401(k) to an IRA Rollover and you won't pay any fees to do this. Here are the steps to do this:
1. You will need to call the number at the top of your old 401(k) statement and request "distribution paperwork." They should be able to email you a form to fill out but some old timey companies will send it snail mail.
2. Pick a new discount brokerage firm and hop online to set up a new IRA Rollover.
3. Fill out the paperwork and have them mail a check directly to the new financial institution where you set up the new IRA. (Don't get the check sent directly to you).
4. Wait a while for the money to make it to your new account. Sometimes it takes anywhere from 2-6 weeks. Call and check in if it's been more than a month. There might be something they're missing on your paperwork.
5. When the money is in your new account you'll need to choose the investments. This means that you have to actually login to the new account and decide which stocks/mutual funds/ETFs you want to buy, otherwise the money will be sitting in cash! We don't want that. (Another reason why I like Betterment is you choose an asset allocation — a stock to bond ratio — and then they immediately invest the funds when the money arrives. They save you this step).
Congrats! You did a very "adulty" thing. Celebrate by watching your favorite show on Netflix while sipping some bubbly.
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