Most of us have worked for a company that offered 401(k) plans to their employees. In fact, you and I have likely worked for multiple companies that provide this benefit. And as a result, you might have a number of 401(k) plans to your name if you opened an account with each employer.
That’s not necessarily a bad thing. After all, most people should always use a 401(k) if their employer offers one — even if the employer doesn’t match. 401(k)s are powerful tax-advantaged accounts that you should take advantage of, whether or not your company chips in, too.
So let’s say you’ve been diligently pumping money into your 401(k) at every company that offered one. But then you changed jobs. You started a new 401(k) at that new company — and then got busy and left the old accounts behind (or maybe even forgot about them). What happens to all those old accounts? Should you do anything about them?
Maybe. It’s important to understand what you can do with old 401(k)s from previous employers and then know the right choice to make for managing those accounts. Here’s what you should know.
The 3 Actions You Can Take with Old 401(k)s
There are three main options that you can explore when it comes to making the decision about what happens to a 401(k) you have with a previous employer. This goes for both traditional 401(k)s and Roth 401(k)s.
You can either:
1. Leave your old 401(k)s with your old employer
The first option is to take no action at all. You can leave your 401(k) where it is, which might make sense if it’s in an excellent, low-cost plan with great investment options. You can’t contribute more funds to it, but you can keep the money invested.
If you’re curious about this option, know that some employers have the power to kick you off the plan. If you’re no longer an employee, sometimes the employer has the ability to decide they don’t want to service the account any longer. In that case, they can open IRA in your name and put your assets in the IRA.
That’s something that’s completely out of your control — and it might have already happened with an old 401(k) and you didn’t even know.
2. Roll your old 401(k) into your current 401(k)
This option assumes that you participate in your new 401(k), which, again, you should be doing if you have access to one! It also assumes your new employer allows you to do this. Check with your benefits department to see if they allow for rollovers into the plan. If so, you could put your 401k(s) from previous employer(s) into your new plan with your current company.
3. Roll the funds from old 401(k) plans to a new IRA
This is the most popular option for many reasons (which we’ll get into below). By rolling over old 401(k)s into one new IRA, you will most likely provide yourself with more options and control over your investments.
For the most part, all three of these options are identical from a tax perspective. Whether you leave your plan where it is, move from 401(k) to 401(k), or do a rollover into an IRA, there are no tax consequences. Many people falsely believe that rollovers trigger taxes, but that’s not true because you’re rolling over into a similar type of account. The only difference is the 401(k) is sponsored by your employer and the IRA is in your name and held outside of your employer.
Why Most People Should Choose to Do a 401(k) Rollover
Choosing to roll over old 401(k) accounts held with previous employers into one new IRA in your name with a custodian you trust is likely your best option. Why? Here are some of the main reasons:
1. You get more investment options.
When you invest money in a 401(k), you’re limited to a select menu of investments available in that particular plan. You might get 10 or 15, and rarely more than 20 or 25. You don’t necessarily need a lot of options to build a good portfolio, but more options does mean more to choose from (and possibly better choices). Using an IRA gives you the opportunity to shop the market and find lower-cost funds to use that better match your financial goals.
2. You may be able to invest in funds with lower fees.
As a general rule, IRAs tend to be cheaper than 401(k)s. You have more flexibility to find investments with lower fees when you invest with an IRA because it’s your account that you hold at an institution you choose. Your 401(k)s leave you stuck with what your employer gives you within the plan. It’s not out of the question to save 1% per year in underlying fees when you roll over to an IRA.
3. You get to consolidate accounts.
Usually when people work on their financial plans, the first thing they start to tackle is improving organization and clarity around their money. Consolidation helps achieve those goals.
When you have a large number of accounts all scattered across multiple institutions, it’s a lot to manage. It’s hard to track balances, fees, and all the other little details associated with each account that you need to know. It makes things more complicated than they need to be when having everything in one place is an option.
Not to mention, when you reach your official retirement and need to take withdrawals from your retirement accounts, having them all at one financial institution is really helpful. If you have 10 different retirement account with 10 different institutions, you have to create withdrawal strategies and processes for each one.
You’ll either need to work to consolidate everything at that point, or work with all of your old employers and financial institutions to coordinate those withdrawals. Consolidation means one less thing you need to worry about with your finances.
4. It’s easier to get help from your financial adviser.
If you want a professional to help you, it’s difficult to have your adviser manage your 401(k) because it’s your account with your employer. Your financial adviser doesn’t have access to that the same way they could help manage an IRA.
With a 401(k), they can’t monitor the account on a regular basis, they can’t rebalance for you, and they can’t execute on investment actions. Rolling assets into an IRA allows you get more help from your adviser should you want professional help managing those investments.
5. You enjoy more tax advantages with an IRA if you care about charitable giving.
The new tax code makes charitable giving less tax advantageous for many donors. However, if you are over 70½, you can give to charity tax-free from your IRA via a qualified charitable distribution (QCD). Employer plans don’t allow QCDs. Starting to consolidate everything into IRAs today allows you to take advantage of QCDs in the future.
6. It’s easier to take advantage of Roth conversions.
As you get closer to retirement, converting traditional IRA dollars to Roth dollars can be really advantageous as you drop into lower tax brackets. They’re not for everyone, but they can be a powerful planning tool — and you can only do them with an IRA.
Another thing to keep in mind when talking about Roths: RMDs are never required with a Roth IRA. But if you have a Roth 401(k), you have to start taking them when you turn 70½. So, at the very least if you have a Roth 401(k), you’ll want to consider rolling it over to a Roth IRA to avoid the hassle of RMDs.
When You Should Leave a 401(k) Plan Behind (or Roll It into Your New 401(k))
All this being said, doing a 401(k) rollover into an IRA isn’t always the best decision for everyone. Doing so comes with a few risks and opens the door for some financial mistakes.
Rolling your money into an IRA might give you lower fees and more options, for example, but that doesn’t do you much good if you get sucked into buying investments that aren’t right for you.
Or you might complete your rollover to an IRA, but then leave the money sitting in cash, which creates a cash drag on your potential returns. This isn’t money you’re going to touch for a long time, so you need to invest it and keep pace with inflation.
Here’s what else to think about before making a final decision, so you can make sure to do what’s best for you.
- Check the costs. While an IRA usually means access to lower-fee investment options, 401(k)s are getting better and costs are going down. This is especially true if you are in the Thrift Savings Plan (TSP) for civil service employees and members of the military. The TSP is a super low-cost plan, so you might want to stick with it assuming low-cost custodians like Fidelity, Schwab and Vanguard don’t provide you with better options and even lower fees.
- Think about backdoor Roth IRA contributions. When you roll your 401(k)s into an IRA and end up with a lot of money in traditional IRA, you will face a greater tax liability when making backdoor Roth IRA contributions. The larger tax liability could very well deter you from taking advantage of this popular strategy. So, make sure you talk to your trusted advisers to determine if backdoor Roth IRA contributions are on the agenda before processing any rollovers.
- You might get more federal protection from judgment creditors. This is not a legal recommendation, but some have suggested that keeping your funds in a 401(k) could protect some of your money from judgments made against you. Here’s an example: If you live in California and a creditor gets a judgment against you — in other words, someone sues you and you lose and owe money — that judgment creditor may be able to collect from your retirement account.
In California, some retirement accounts, such as 401(k)s and profit-sharing plans, may be protected from this. Other accounts, like IRAs, may be more vulnerable. Again, this is not legal advice and if you have specific questions around this, check with your attorney to get clarity on this specific issue. But if you are someone who is concerned about judgments, like doctors who may be at risk for cases brought against them, this is one reason to pause and think before doing a 401(k) rollover to an IRA.
Ultimately, the best choice for you when it comes to rolling over your 401(k) accounts with previous employers (or not) comes down to the details of your situation. While rolling 401(k)s into a single IRA with a custodian you trust makes sense for most, there are always exceptions. Carefully evaluate your choices and run the numbers on each before making a final choice on what to do with those 401(k)s you might have left behind.
Taylor Schulte, CFP®, is founder and CEO of Define Financial, a fee-only wealth management firm in San Diego. In addition, Schulte hosts The Stay Wealthy Retirement Podcast, teaching people how to reduce taxes, invest smarter, and make work optional. He has been recognized as a top 40 Under 40 adviser by InvestmentNews and one of the top 100 most influential advisers by Investopedia.