Job change: what to do with the old plan

In short

A friend of mine left a job last spring and stared at the retirement plan statement for three weeks before doing anything. You have four choices when you walk away from an employer: leave the money where it is, roll it into your new employer's plan, roll it into an IRA you control, or cash out and pay the taxes and penalties. Leaving it alone is fine if you like the investment options and the fees are low. Rolling to an IRA gives you the widest menu of investments and keeps the tax shelter intact. Cashing out before fifty nine and a half costs you income tax plus a ten percent penalty on everything, so most people treat that as a last resort. Make the choice before the old provider starts sending you letters.

The whole of it

What it is

You spent years putting pre tax dollars into a 401(k) or 403(b), and now you are heading somewhere new. The account does not evaporate when you leave. It sits there with your name on it until you decide what happens next. The law calls this a distribution event, which simply means you are allowed to move the money without working there anymore. You are not required to do anything immediately. The account stays tax deferred no matter which path you choose, as long as you follow the rollover rules. If you take cash, the tax bill arrives the following April.

How it works

Your old plan administrator will ask what you want to do. One option is to leave everything in the old plan. If the balance is above five thousand dollars, most plans let you stay as long as you like. The investments keep growing or shrinking with the market, and you log in just as you did before. Some people end up with three or four old plans scattered across a decade of jobs.

The second option is moving the money into your new employer's plan, assuming that plan accepts rollovers. You fill out a form at the new provider, and they request a trustee to trustee transfer from the old one. The money never touches your hands, so no tax event occurs. You end up with one account and one statement instead of two.

The third option is rolling everything into an IRA that you open at a brokerage or fund company. This is a direct rollover as well. The old plan cuts a check to the new IRA custodian, you deposit it within sixty days, and the tax deferred status continues. An IRA usually offers thousands of investment choices instead of the fifteen or twenty in a typical employer plan.

The fourth option is cashing out. You ask for a check made out to you. The plan withholds twenty percent for federal tax right away and sends you the rest. When you file your return, you report the full amount as income, pay tax on your marginal rate, and if you are younger than the current figure, which the official source publishes each year you pay another the current figure, which the official source publishes each year penalty on the whole sum. Some states add their own income tax on top.

The numbers, and where to find yours

Every plan statement shows your vested balance. Vested means it belongs to you. Your own contributions are always fully vested. Employer matching or profit sharing dollars vest on a schedule, often twenty percent per year until you reach five years. If you leave before you are fully vested, you forfeit the unvested portion. The statement will list two numbers: total balance and vested balance. The vested number is what you can take with you.

Investment expenses live in two places. The plan itself may charge an annual administration fee, anything from zero to around fifty dollars. Each mutual fund inside the plan charges an expense ratio, a percentage of assets every year. You can find those ratios in the fund fact sheets on the plan website. Your own plan statement or fact sheet will show what you are paying. The difference compounds over decades.

If you roll to an IRA, the new custodian may charge an account fee and the investments you choose will have their own expense ratios. Many brokerages charge zero account fee. Compare what you pay now to what you would pay elsewhere before you move anything.

A worked example

Imagine Sarah leaves a job with thirty two thousand dollars vested in her 401(k). She is thirty four years old and moving to a new employer that offers a 401(k) with similar investment options. The old plan charges a thirty dollar annual fee and offers index funds averaging 0.15 percent expenses. The new plan charges no admin fee and offers index funds at 0.04 percent. Sarah also looks at opening a rollover IRA at a brokerage that charges no annual fee and offers the same index funds at 0.03 percent.

If Sarah leaves the money in the old plan, she pays thirty dollars a year plus 0.15 percent of thirty two thousand, which is forty eight dollars, for a total of seventy eight dollars in year one. If she rolls to the new 401(k), she pays zero admin fee plus 0.04 percent of thirty two thousand, or about thirteen dollars. If she rolls to the IRA, she pays zero fee plus 0.03 percent, or about ten dollars. Over thirty years the difference in expense ratios alone will be thousands of dollars because the fees come out every year and reduce the amount that compounds.

Sarah decides to roll into the IRA because she wants to add a small allocation to real estate investment trusts, which her new plan does not offer. She calls the old provider, requests a direct rollover, and gives them the IRA account number at her brokerage. Three weeks later a check arrives at the brokerage, made out to the IRA custodian for benefit of Sarah. The brokerage deposits it. No tax form arrives in January because no distribution went to Sarah personally. The entire thirty two thousand continues growing tax deferred.

Where it goes wrong

People take the check in their own name, spend some of it, and then realize they owe taxes and a penalty on everything. The sixty day rollover window is real. If you deposit the money into a qualified IRA within sixty days, you avoid the tax. If you miss the deadline, the entire amount becomes taxable income that year. The IRS allows one sixty day rollover per twelve months across all your IRAs, so if you have already done one this year you cannot do another until the period resets.

Another mistake is rolling a Roth 401(k) into a traditional IRA. Roth money has already been taxed, so it must roll into a Roth IRA to keep its tax free status. Mixing the two creates a mess. The plan administrator will ask which type of IRA you are using. Make sure the registration matches.

Some people leave tiny balances behind and forget about them. If your vested balance is below one thousand dollars, many plans will force you out and mail a check. If the balance sits between one thousand and five thousand dollars, Internal Revenue Code Section 411 permits the plan to move your money into an IRA without asking you first. You get a letter telling you where it went. The investments and fee structure in that IRA depend entirely on the arrangement your old employer made with the provider. Track down those old accounts before the plan does it for you.

A final problem is paying a financial advisor a percentage of assets to manage a rollover IRA when the old plan offered perfectly good index funds at low cost. A one percent annual advisory fee on thirty thousand dollars is three hundred dollars a year. If the advisor is providing real financial planning, that might be worth it. If the only service is picking three mutual funds, you are paying for something you could do in an afternoon of reading.

Questions to answer before you leave this page

What is your vested balance in the old plan and where is that number on your statement? What is the annual administration fee in the old plan and the expense ratios of the funds you own? Does your new employer's plan accept rollovers and what are the fees there? If you open a rollover IRA, which custodian offers the investments you want at the lowest cost? Are any of your old plan dollars in a Roth account that must roll to a Roth IRA? If you request a check, will it be made out to you personally or to the new custodian for your benefit? Have you done any IRA rollovers in the past twelve months that would prevent another sixty day rollover? Do you know the deadline for moving the money before the old plan forces a distribution?