retirement

The Biggest 401(k) Mistake People Make

You've got four options for what to do with your 401(k) when you leave a job, and one of them is pretty bad.

Changing jobs? You might be unaware of the choices available to you for the money in your 401(k) account.

People often assume that when they leave a job, the money must leave with them. This common misperception often emanates from financial advisers, brokerage firms and mutual fund companies, all of whom are often incentivized to encourage you to move your 401(k) to potentially higher cost IRAs.

Fortunately, not all financial planners behave this way. Many are devoted to helping their clients get the most out of their retirement savings. So be sure that, when getting information about your 401(k), you’re getting advice from a financial adviser who acts as a fiduciary — meaning they are serving your best interests (instead of their own).

Common Misconceptions Can Cost You Money

A recent Financial Engines survey found that many Americans don’t know they might be able to keep money in a former employer’s 401(k) plan. Indeed, of individuals between 35 and 65 years of age who left a job where they had a 401(k), nearly half (42%) didn’t know this. So, it’s no surprise that many of those surveyed also didn’t know the consequences of their rollover decisions.

That’s why it’s so important that you understand your options, so you can choose what’s best for you. Here are the choices available to you when you leave your employer:

Withdraw the money and spend the cash.

Yes, you’re allowed to liquidate your 401(k), but you shouldn’t. In fact, more than one-third of survey respondents (34%) said they had done this prior to retirement. Younger Baby Boomers (38%) were most likely to have done so, compared to 31% of Gen Xers (ages 39-54) and 36% of older Millennials (ages 35-38).

Unless you’re facing a dire circumstance, withdrawing cash from your 401(k) is a bad idea, and should only be done as a last resort. Not only is the money gone — never to be available to you in retirement — you’ll owe income taxes plus a 10% IRS penalty if you’re under age 59½.

Roll over the money to an IRA.

Some employees do a “rollover” — moving the money to an IRA. Many financial advisers, brokerage firms and mutual fund companies encourage this option, so they can earn commissions on the transaction or fees by managing the assets. The question you must answer is whether the rollover to an IRA is in your best interests. And, sometimes, it is: An IRA might provide you with investment opportunities not available in your 401(k). And by moving assets to an adviser, you might obtain services you otherwise wouldn’t receive. Thus, it’s important to understand the costs and the benefits, so you can make an informed decision.

Transfer the money to your new employer’s 401(k) plan.

Not all employers offer this choice, but it’s worth considering if yours does. Consolidating your accounts in one place makes it easier to manage your money. This option may be best if you’re satisfied with the investment choices available in your new employer’s 401(k) plan.

Leave it where it is.

And what is often the best option is one ignored by many employees: Leave the money where it is, in your former employer’s 401(k) plan. Many plans offer low fees and good investment options, so consider this choice before you act. The greatest benefit of remaining in a former employer’s plan is having access to the institutional buying power and high-quality plan design that many leading employers have made available. The result can be potentially much lower fees, which translates into increased retirement savings over the long-term, and more varied and higher-quality investment options.

While you may need to track multiple accounts if you leave a 401(k) at an old employer and open a new one at your current job, the upside is that you can have more savings.

And as you evaluate your options, you likely will find it easier to make the best choice by working with a trusted, independent financial adviser. Nearly 80% of those surveyed by Financial Engines said they believe it is important to get financial advice from an adviser who is a fiduciary.

The Bottom Line

By understanding your retirement savings options when leaving a job, you can be more confident that you can achieve your financial goals.

About the Author

Ric Edelman, Founder

Chairman of Financial Education, Edelman Financial Engines

Ric Edelman is a founder and Chairman of Financial Education and Client Experience at Edelman Financial Engines.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
The 25 Cheapest U.S. Cities to Live In
places to live

The 25 Cheapest U.S. Cities to Live In

Take a look at our list of American cities with the lowest costs of living. Is one of the cheapest cities in the U.S. right for you?
October 13, 2021
15 U.S. Cities With the Highest Average Home Prices
real estate

15 U.S. Cities With the Highest Average Home Prices

Home prices have rocketed higher across most of the country, but housing costs are acutely painful in these 15 U.S. cities.
October 20, 2021

Recommended

Boost Your Retirement Savings for 2022
Financial Planning

Boost Your Retirement Savings for 2022

If you were self-employed or had a side hustle in 2021, you can save even more in a tax-advantaged account.
October 26, 2021
The Best Fidelity Funds for 401(k) Retirement Savers
Investing for Income

The Best Fidelity Funds for 401(k) Retirement Savers

Fidelity funds are renowned for their managers' stock-picking prowess. We rate Fidelity's best actively managed funds that are popular in 401(k) plans…
October 25, 2021
From EBRI's CEO: What's on Retirees' Minds
Empty Nesters

From EBRI's CEO: What's on Retirees' Minds

Retirees feel more comfortable spending from steady sources of income rather than tapping their nest egg.
October 25, 2021
How Snowbirds Can Be Taxed as Florida Residents
retirement

How Snowbirds Can Be Taxed as Florida Residents

If you live in a high-tax state during the summer but winter in Florida, you can save big bucks by establishing residency in the Sunshine State.
October 25, 2021