When you change jobs, you have plenty to manage: the physical move, the new boss, altered assignments and responsibilities. The last thing you're likely to think about is the money left in your previous employer's 401(k) plan. In fact, according to research firm Cerulli Associates, more than one-third of all 401(k) balances currently lie dormant , with no further contributions being made. Given that the average employee changes jobs every four or five years, it's not uncommon to have amassed several of these untended accounts that may be housed at far-flung financial institutions.1
While the assets aren't necessarily in danger, there are risks to such inertia. If you're not monitoring the performance of investments in these orphan accounts, you won't know whether your overall portfolio is aligned with your goals—and since you may have made many of the investment decisions long ago, it probably won't be. "Your asset allocation could be completely out of line with where you stand now in terms of your stage of life, your degree of wealth and your goals," says Bill Hunter, director of Personal Retirement Solutions at Bank of America Merrill Lynch. By consolidating old accounts in one place, you can look at your assets holistically and ensure that no one basket is holding too many eggs.
Your Financial Advisor can help you review your options and, if you choose to roll over the assets from one plan to another, will help with the necessary paperwork and other logistics. Here are some options, and the pros and cons, to consider:
1. Transfer to a traditional IRA.
The simplest solution is to move the assets into an IRA, which allows for continued tax-deferred growth potential. IRA accounts typically have a broader selection of investment options to choose from than 401(k)s, and you may have better access to investment advice. Make sure to do a direct rollover, so you don't have to take possession of the assets before they go into the new IRA account, Hunter says. If you do not do a direct rollover, you have only 60 days to complete the move; if you exceed the deadline, you could get hit with a 10% early withdrawal additional tax in addition to ordinary income tax. On the downside, assets in an IRA are protected from creditors only if you declare bankruptcy, while 401(k)s offer broader shelter. Also, with an IRA, you may be charged an annual fee to maintain your account, and commissions and sales charges may also apply to investment transactions, while 401(k) plans usually don't charge fees per transaction.
2. Transfer to a Roth IRA.
A Roth is built with after-tax contributions, but investments have the potential to grow tax-free, and your withdrawals then will be tax-free provided they are taken as a qualified distribution. If you think your marginal tax rate will be higher after you retire, that would be one good reason to consider a Roth, Hunter says. A Roth IRA may also offer more flexibility in naming beneficiaries other than your spouse. But to achieve those benefits, you will owe income tax today on the total pre-tax amount that you transfer from a tax-deferred IRA into a Roth. "We typically recommend that you pay those taxes out of a different pool of money so you don't reduce the principal," Hunter notes. So you'll want to factor in whether you have cash available to pay that tax bill. Rolling over a 401(k) to either a Roth or a traditional IRA may mean foregoing favorable tax treatment for employer stock that you may have in your employer's plan.
3. Add it to your new 401(k).
By rolling it to a plan at your new job, you get the benefit of consolidation. "You have all of your retirement savings top of mind, so you can watch performance and allocation to make sure it's not misaligned," says Hunter, adding that this does preserve those broader protections from creditor claims that a 401(k) provides. Also, assuming your plan allows it, you may borrow against your 401(k) assets if you need liquidity, which is not an option with an IRA. But Hunter cautions that taking a loan from your retirement assets should be considered a last resort. It may result in loss because those assets do not have growth potential while the loan is in place. "And if you leave your job for whatever reason," Hunter says, "you'll generally have a very short window of time to pay back the loan."
4. Keep it in your old employer's plan.
Consider this option if you're undecided about what to do with the assets and you're satisfied with the investment choices in your former company's plan. There are typically no fees associated with investment transactions, so you can make changes to your asset allocation relatively easily. On the downside, beyond the issue of limited investment choices compared with a typical IRA, if you have less than $5,000 in your account, your employer could require you to move those assets.
5. Take a lump sum distribution.
This is, indeed, one of your possibilities—but consider it only in a financial emergency, Hunter says. "Sadly, a lot of young folks take that option because they don't fully appreciate the ramifications of taking it out and losing the power of compounding investment growth potential." According to consulting firm Aon Hewitt, 42% of workers who lost their jobs in 2010 cashed out their 401(k) plans, with younger workers and those with smaller balances most likely to take that path. Before you think about withdrawing the money, ask your Financial Advisor to calculate the potential compounded growth you could see by the time you retire if you kept the money in a tax-deferred IRA or 401(k). "When you see the number," Hunter says, "it starts to make sense."