The average American employee switches jobs 11 times before retiring. This means many have old 401(k) or work retirement plans that may not be invested properly. Because for most people their 401(k) is their only work retirement account, it is important to maximize their 401(k) accounts. Every time you change jobs, you have four options to take with your 401(k):
- You can leave the assets in the old employer’s plan (if the plan permits it).
- You can roll the assets over into your new employer’s plan (if one is available and the plan permits it).
- You can roll the assets over into an Individual Retirement Account (IRA).
- You can take a cash distribution (and deal with the potential tax consequences and penalties).
Each of these options has some advantages and disadvantages. Here are four steps that will help you avoid common (and expensive) mistakes and how you can use your 401(k) rollover to maximize your retirement. To learn more about 401(k) plans and how it works, click here.
- Roll over your 401(k) to get access to more (and often) better investment choices. Workplace retirement plans often offer limited investment options that may not be right for your financial situation. Since every investor has a different risk tolerance level, goals, and time horizon, you want to have an investment portfolio catered to your needs. In contrast to most 401(k) plans, IRAs can hold nearly any type of investment, giving you more flexibility in your investment strategies.
- Keep more of what you earn by slashing expenses. One study showed that the average 401(k) plan has 17 different admin and investment fees and costs that can average anywhere from 3% to 5% a year! If you were to save $10,000 per year with an 8% return, paying 2% more in fees over 30 years will result in a difference of $385,441.91.
Even if you rollover your old workplace account to your current 401(k), you still may be subject to the high costs and fees. IRAs have simple fee structures that make it easy to know exactly what you’re paying for and why. I recommend using exchange-traded funds (ETFs) that have an average expense of 0.15%. For more information click here.
- Don’t be tempted to cash out! If you decide to liquidate and receive the money directly, it may be a quick source of cash, but can cost you thousands in penalties and taxes, as well as prohibit you from years of future growth. If you decide to take a distribution or check from your old plan, or you don’t roll the assets over within the 60-day window, your old plan administrator will require an automatic 20% withholding tax and be reported to the IRS.
If you delay moving the assets to your IRA account, you could miss your 60-day window and be forced to pay penalties and taxes on your entire distribution. I recommend that you do a direct rollover that transfers your assets from your old plan directly to your IRA account. This process is simple and not reportable to the IRS.
- Take control of your financial life. For your current 401(k) or workplace retirement account, I always recommend to take a look at what investment options are available and make sure you are allocated properly. For your old work accounts, rolling them over to an IRA can help you simplify and take control of your financial life.
In my experience, investors tend to lose track of accounts that aren’t right in front of them. Life gets busy and failing to modify your investment strategies regularly to make sure they keep up with your needs can undermine your long-term financial success. As an ex-employee dependent on the plan, you may not be able to make changes to your investments, preventing you from adjusting your allocations.