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401k Graveyard: What can you do with your old 401k?

Joseph Crowley, CFP®
Dec 7, 2021

What can you do with your old 401k?Over the years, the frequency at which individuals change jobs has drastically increasedThis rate has spiked with “The Great Resignation”, an interesting side effect of the pandemic, however an additional factor for the increase lies in the structure of our current retirement system. With the introduction of the 401(k) came a transition away from single career track linked to a sizable pension. Individuals were suddenly free to change professions without leaving behind a key part of their retirement. But as careers change and retirement nears, what really are the best decisions to make when it comes to what is likely our largest asset. Understanding the options are critical for retirement success because once an election is made, it may be difficult if not impossible to reverse that decision. Below you will find the four options for old employer sponsored retirement plans which includes 401(k)s, 403(b)s, 401(a)s, and 457(b)s:

Leave It Where It Is

The simplest method would be to leave the assets under the currently administered plan. Participants would still have access to the funds within the retirement plan, but many of the benefits may be revoked such as contribution or loan options. One special perk of this decision could be the ability to access funds prior to 59.5 without incurring the common 10% early withdrawal penalty. This is often an option within plans when a participant leaves employment after age 55. Therefore, if you plan on retiring early, it may be most beneficial to leave your retirement plan untouched as to keep intact the ability to distribute needed spending dollars. One final benefit is the creditor protection 401(k)s are wrapped in. If there is the slightest possibility of filing for bankruptcy, keeping funds in a 401(k) could protect a significant asset. 

Transfer To An IRA

The most frequently utilized option would be to transfer funds from a previous employer plan into an IRA. Benefits of this decision include the removal of administrative costs and restrictive (and possibly expensive) investment options. An individual gains more control over their assets rather than needing to work with a 401(k) custodian or their HR department to access their account. However, this decision can be daunting for those who manage their own portfolio as they quickly realize that the limited investment options may have in fact been a benefit. While employer sponsored plans are known to be restrictive in what they allow you to invest in, an underlaying benefit is the reduction in one’s ability to make harmful investment choices. With thousands of options in a self-managed IRA, investors can quickly go from a well-diversified and balanced retirement account to a highly concentrated overly engineered portfolio. This option also holds a certain level of risk as if not processed properly, you may be faced with a sizable tax bill. Keep in mind that almost all employer plans should be rolled into IRAs prior to age 72 in order to simplify required minimum distributions. This is especially true if the account holds after-tax or Roth funds. Lastly, electing this option could impact utilization of the Backdoor Roth IRA strategy or complicate IRAs with existing after-tax funds (non-deductible IRAs).  

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Transfer To a New Plan

Those who transition jobs more frequently than others may find the best option is to simply transfer an old employer plan into a new offering. This strategy could result in fewer investment accounts and could add to existing benefits of employer plans by increasing the account size. Therefore, individuals who are still searching for their career track may find this option attractive. Just be sure to verify the ability with your new employer as not all retirement accounts are designed the same. This chart is a useful tool to check if a new plan is capable of receiving funds from a prior plan. 

Cash Out

The least frequently recommended option would be to cash the retirement plan out as a normal distribution. All pre-tax dollars are treated as ordinary income which could lead to unnecessary taxes being paid. The benefit would be the immediate access of cash, but the downsides often outweigh that benefit. In many instances, this election is made in conjunction with others which allows participants to receive a partial distribution from their plan while simultaneously choosing from one of the other three choices for the remainder of the account. An additional consideration on employer plan cash distributions is the requirement for tax withholding. The IRS typically imposes a 20% federal withholding election which may or may not line up with your tax liability or payment strategy.  

We’ve dealt with retirement plan providers such as Fidelity, Schwab, Vanguard, TIAA, Paychex, Voya, American Funds, Prudential, Empower, The Standard, Lincoln, Transamerica, and so many more. One thing is for certain, regardless of the decision made, the process should not be taken lightly. Each plan within each provider has its own requirements and procedures. Once the process is finally made clear, topics such as pre-tax, post-tax, and Roth funds are brought up. You’ll be asked to verify you’ve read certain tax disclosures and to review the option or mix of options you’ve elected. And if net unrealized appreciation (NUA) or existing plan loans come up, you better be prepared to hang up the phone and call your financial advisor and/or accountant. While this article was written with the intention of outlining the benefits and downsides of options for retirement plans, it is not to be taken as a form of recommendation or instruction manual for processing an election. Regardless of your age, income, or account balance, each transition for a plan should be carefully reviewed with a financial professional. 

Download this handy flowchart for a visual representation of the information discussed above!

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Joe Crowley, CFP® is an Investment Advisor at Exchange Capital Management.  The opinions expressed in this article are his own.