How (and Why) to Roll Over Your 401(k)

Most people will work for several companies throughout their career. As you move to another company, you should be careful not to forget about your retirement investments. Unless your old employer’s plan had solid and low cost investment options, you should seriously consider rolling your investments over to an IRA.

Aside from increasing your investment options, rolling your 401(k) protects you from early withdrawal penalties associated with cashing in your account. The key is finding a way to manage your retirement fund effectively and stick with your overall retirement plan.

Why cashing out is a bad move

When moving from one job to another, you might be tempted to cash in your retirement account to pay off some bill, or even have a little bit of fun. Don’t do it. If you do, you’ll get hit hard. Twice.

For starters, you’ll expose that money to income taxes, and it might even be enough to bump you into a higher tax bracket. On top of the taxes, you’ll also get hit with a 10% early withdrawal penalty.

I learned this the hard way when I changed jobs years ago. Since I didn’t meet the minimum balance requirement to keep my old 401(k) open, I was sent a check with the balance of my account.

I should have immediately opened an IRA and completed a rollover, but instead I used it to pay off bills. I thought I was being smart, but the penalties ate a good chunk up of my savings, and I was left with no retirement savings.

I won’t ever do that again. Next time, I’ll inform HR to send it to my IRA directly, avoiding the temptation for me to spend the cash.

Where to roll over your 401(k)

You have two options for rolling over your retirement fund, either to an IRA or into your current company’s 401(k). You’ll have to the weigh the pros and cons for yourself.

Into an IRA

You’ll have complete control over your money with an IRA. You can choose your preferred brokerage or mutual fund company, and you’ll likely wind up with more and better investment options than with a 401(k).

If you’re working with a financial planner (fee only, please!), feel free to ask for their advice on the matter. I would also suggest you check out some of the following companies to see if they would fit your needs:

Charles SchwabVanguard T. Rowe PriceFidelity

In most cases, you can initiate the rollover online. Just be sure to have all of your old 401(k) information on hand. When we opened an account with Vanguard, we were able to fill out all of the information online, but we still had to sign and mail the documents.

As with any financial transaction, just be sure to read all of the paperwork carefully, and don’t be afraid to call and ask questions if anything is unclear.

New company’s 401(k)

The primary advantage of this option is simplification. By rolling your investments into your new 401(k), you’ll have one fewer account to deal with. Another advantage, if you want to call it that, is that you can borrow from your 401(k), but not an IRA.

In my view, the ability to borrow isn’t typically an advantage, though there are some circumstances in which it might be the best option available. By having all of your funds in a 401(k), you’ll have a larger balance to borrow against.

Another consideration, of course, is whether or not your new plan accepts incoming rollovers. Even if they do, you might have to satisfy a minimum waiting period before you’re eligible.

Choosing your investments

If you’re looking for the easiest option that you can set and forget, you might want to look into target date mutual funds. These funds are designed to adjust asset allocation as you get closer to the retirement date, though there are some disadvantages to them.

Index mutual funds are another great option for people who are willing to construct their own portfolio while minimizing their expenses. Index funds are designed to track specific market indices, and thus don’t incur expenses associated with an active fund manager.

Exchange traded funds (ETFs) are similar to index funds in that they typically track a market index. ETFs can be traded through out the day like stocks. One major downside of ETFs is that, depending on where you buy and sell them, you may have to pay brokerage fees.

If you’re looking for some more information to help you decide, there are plenty of posts on the topic here at FiveCentNickel:

Index Mutual Funds vs. Exchange Traded Funds (ETFs)ETFs vs. Index Mutual Funds, RevisitedAvoiding and Reducing Mutual Fund Fees and ExpensesStocks and Bonds vs. Mutual Funds

And here are some articles on asset allocation:

Our Investment Portfolio: Asset Allocation and LocationReconsidering Our Asset AllocationThe High Cost of Low Risk InvestingHow Much International Exposure Should Your Portfolio Have?Market Turmoil, Portfolio Drift, and Asset Allocation: Time to Rebalance?

I would also recommend reading a few good books on investing if you’re going to start taking a more active role in managing your portfolio.

Your Thoughts on Rolling Over Your 401(k)

Have you changed jobs in the past? If so, how have you handled your associated retirement savings? Did you leave it in place? Roll it into an IRA? Or maybe you rolled it into your new 401(k)? Do you have any tips for making the process easier?