THE CLASH, the U.K. punk-rock group, famously asked, “Should I stay or should I go?” Retirees and job changers need to tackle the same question when they leave their employer.
At that juncture, you have four options for your 401(k) or 403(b) account: You can leave the balance in your old employer’s plan, roll over the balance to a new employer’s plan, roll over the balance to an IRA or close out the account.
You can generally keep your retirement savings in your old employer’s plan, even if terminated, provided you have a balance of $5,000 or more. When you leave employment, you’ll likely have to pay back any outstanding loan balances and, if not fully vested, surrender some or all of the matching funds.
Will you lose part of the employer’s matching contribution? My advice: Carefully check the plan’s prospectus before assuming the entire account balance will be yours. The prospectuses for many large company plans are posted on the web, while most smaller companies outsource their plan’s administration. If in doubt about account balances or policy, check with your human resources department or plan administrator. There could be the chance for easy money: You may find that more of the employer’s match will vest if you simply delay your departure by a week or two.
You may want to leave your money with the old employer if the plan has low costs and broad investment choices. That might include institutionally priced funds that you couldn’t access on your own or a stable value fund offering higher-than-market interest rates. On the other hand, if the plan has high fees and mediocre investment options, run for the exits.
What about retirees? Again, it depends on the quality of the plan. Many retirees of my former employer stay with the company’s well-managed and low-cost plan for decades.
If your former employer’s plan is administered by a financial services company, often the financial company will be anxious to retain your account. Indeed, my wife has hung onto two old 401(k) accounts for 18 and 28 years. Both are administered by financial companies.
After she left those two jobs, both employers offered buyouts of their modest pension plans. My wife rolled the payouts into her 401(k) accounts, where the pension assets have been compounding ever since. The money feels safer invested with a financial services firm than as the pension obligations of smaller companies.
While employees can transfer 401(k) assets from an old employer to a new employer, this may not be a top choice, unless the new employer’s plan is exceptionally good. If you want to compare plans, BrightScope provides details and ratings for thousands of employer plans, and highlights those plans that provide better options.
The good news is, 401(k) and 403(b) accounts can be readily rolled over into an IRA at any financial firm. When my daughter was laid off because her employer exited one of its businesses, she simply transferred her 401(k) balance to an IRA with a low-fee financial services firm. She now has more control of her assets. She also has far more investment choices, including a full-range of target-date funds and access to low-cost index funds, plus added flexibility when rebalancing. In addition, she’s now diversified across institutions, because she has her rollover IRA, her 401(k) at her new employer and a Roth IRA invested elsewhere.
One wrinkle to keep in mind: If you want to take advantage of the so-called backdoor Roth by funding a nondeductible IRA and then converting it to a Roth, you’ll want to keep the 401(k) money at your old employer or roll it into your new employer’s plan. If you move the money into an IRA, it’ll cause those backdoor Roth conversions to trigger much larger tax bills. You can learn more about this in HumbleDollar’s money guide.
The final option is to close out the former employer’s account and take a distribution. This surrenders the tax deferral, creates an immediate tax obligation and, if you’re under age 59½, usually triggers a 10% tax penalty. Those are all bad outcomes—all of which you’ll want to avoid.
John Yeigh is an engineer with an MBA in finance. He retired in 2017 after 40 years in the oil industry, where he helped negotiate financial details for multi-billion-dollar international projects. His previous articles include Got You Covered, Nothing to Chance and Hers, His and Ours.