Twenty-first century America is a nation of job-hoppers. According to the U.S. Bureau of Labor Statistics, the average American holds 12 jobs in their lifetime. The concept of retiring after 40 years with one company, taking home a pension and a gold watch is a thing of the past. But switching jobs every few years could result in a lot of abandoned 401(k)s. Workers may be leaving behind thousands of dollars and a hodgepodge of old, obsolete retirement accounts. If you have moved jobs several times, chances are you have multiple 401(k) plans out there!
Why Consolidate Your Old 401(k)s
More often than not, it makes the most sense, both financially and behaviorally, to merge 401(k) plans. Let us explain why! It is easier to have a cohesive investment strategy and to manage the assets together. With multiple accounts, it can become difficult and confusing to make sure you have the right investments in the right accounts. Merging the plans makes your investments simpler to track and cuts down on the number of statements you’ll receive. When it comes time to take your Required Minimum Distribution (“RMD”) at age 72, it is more straightforward to distribute from a single account. If you are still employed, you can avoid taking RMDs from old plans if they have been consolidated or merged into your most current 401(k).
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Other Options to Consider
There are several other options to consider when you are deciding what to do with multiple 401(k)s.
- Keep the old 401(k) in place with your former employer: Most companies will allow you to hold your retirement savings in their plans even after you leave. If you like the way the investment allocation and options are designed, you may want to keep your money where it is. Federal law offers broad protection for 401(k)s against creditors. Leaving it can be an option!
- Roll over your old 401(k) to your new employer’s 401(k): Be aware that not all employers will accept a rollover from a previous employer’s plan, so check with your new employer’s administrator before making any decisions or setting up accounts. If you are 72 or older and are required to take your Required Minimum Distribution, you may be able to defer that annual distribution if you are still working for your current employer.
- Roll over the money in your 401(k) to an IRA: An IRA may offer more investment options and lower fees than your 401(k). But if you want to do a backdoor Roth IRA (link to article), it can complicate things a bit. If this is a strategy you want to explore, we recommend not rolling the 401(k) to an IRA until you have discussed your options with a financial advisor. The other thing to consider when turning your 401(k) into an IRA is that IRAs may offer limited creditor protection.
- Cashing out your old IRAs: If you have less than $5,000 in the 401(k) plan, the money may be automatically sent to you. Taking money out of 401(k)s or other retirement vehicles should be avoided unless the immediate need for cash is critical and there are no other options since the cash distribution would be taxed as ordinary income. If you are younger than 59 ½ years old, there may be a potential 10% early withdrawal penalty, as well. To avoid taxes and penalties, we recommend rolling over the money to an IRA rather than cashing it out.
Direct Rollover vs Indirect Rollover
When moving or rolling money from one IRA or 401(k), the rollover can be direct or indirect. It is important to understand the differences and tax implications.
Direct Rollover
- A direct rollover moves the money directly to the new account without the owner technically having it in their “hands.” This occurs when the retirement account administrator sends the money directly to the new account. In some cases, the account administrator sends you a check made out to the new IRA “for the benefit” of you. Once the check is received, the check is mailed to the new custodian of the IRA. The money is never technically in your hands since you are unable to cash the check and the IRS treats this as a direct rollover.
- With a direct rollover, no taxes are withheld.
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Indirect Rollover
- If an indirect rollover is made, the retirement account administrator sends you a personal check. If the proceeds are re-invested into a new retirement account within 60 days, you do not owe taxes or penalties.
- Generally, the employer is required to withhold 20% for federal income tax when doing an indirect rollover.
- If the indirect rollover is not accomplished properly, it can leave you owing income taxes, and an early withdrawal penalty.
- Only one indirect rollover is allowed in a 365-day period.
Because of the potential tax implications of indirect rollovers, we strongly encourage direct rollovers when moving money from one retirement account to another. When it comes to deciding what to do with an old 401(k), there may be factors that are unique to your situation. As with many financial decisions, the best solution will be different for everyone. At Blankinship & Foster, we specialize in helping our clients simplify their accounts by consolidating, when it makes sense. Our sound financial advice is based on the vast experience of our team and the many situations we have encountered with our clients. We pride ourselves in being among the top financial advisors in San Diego and can counsel you through pre-retirement as well as retirement decisions. Contact us today!
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