I’ve gotten this question from a few clients and friends over the past few months. Most have already found a new job and started saving into their new company’s retirement plan, but they’re worried about making a mistake if they move the old account.
For those in this position, you typically have 5 main options (from worst to best):
1. Cash it out - (WORST OPTION)
This is almost always the worst option to select. By cashing out a retirement plan before reaching 59 ½, you’re agreeing to send about half of your vested balance to the IRS. The entire amount becomes completely taxable, and a 20% penalty is immediately deducted from the balance on top of that.
2. Convert to a Roth IRA – (USUALLY BAD)
Rolling an old 401(k) into a Roth IRA (or Roth 401k) is usually not the best choice because the entire amount rolled over will be taxed. However, there’s no 20% penalty in this case, AND this type of rollover will shift the account to a tax-free Roth IRA (with some rules).
The uncommon scenario when it may be best to roll it into a Roth IRA is if you don’t find a new job for a considerable time period during the year and your income is low enough for that calendar year that you’re in a low tax bracket. Thus, paying the taxes on this rollover won’t be substantial and you’ll benefit from shifting the balance to a Roth IRA.
3. Leave it in the old 401(k) – (A BIT BETTER, BUT STILL BAD)
While an old 401(k) account left at its original company won’t be penalized or taxed, this is a common mistake I see people make. First off, you’ll often lose sight to the account, and it becomes difficult to know what’s in it. It’s also important to know what your old company will do with the account—some companies will transfer it to their “orphan accounts” department where it’s no longer invested, and simply sitting in cash earning less than 1% interest.
4. Roll into New Job’s 401k – (BETTER)
Combining an old 401(k) into your current company’s plan is a good choice, because it consolidates your retirement accounts, and you’re left with one fewer account to keep track of. There’s also a financial planning strategy (called backdoor Roth contributions) that can benefit high-income earners by leaving funds in a 401(k).
5. Roll into a Traditional IRA – (BEST)
For most people, rolling an old 401(k) into a Traditional IRA is the best option. It provides the flexibility to be managed either by a professional advisor or yourself, and it opens the investment options up to the entire world of stocks, bonds, and funds; not just the limited options offered within a new 401(k).
It is important to note that if this option is selected, you have 60 days to get the check from the 401(k) to an IRA before the entire amount becomes taxable.
Looking for direction on which option is best for you? Schedule a no-obligation meeting with Brennan here: https://www.boulevardwealth.com/mccarthy