Most of the time, it pays to be deliberate with your investments. Amateur investors are more likely to get in trouble by being too hasty to buy or sell. Slow and steady investing over the long haul, I believe, usually wins the race.
But there’s one transaction with which it pays to move quickly: when completing a 401(k) rollover. You could face a nasty tax and penalty bill if you delay or dilly-dally.
401(k) rollovers are common. If you’re in your thirties or forties (or older), there’s a good chance you’ve had multiple jobs by now. And if you saved money in a 401(k) at a previous employer, you might have wondered what to do with it after you left. Here are a handful of options, each with its own set of pros and cons. But beware, the last two might require you to move fast.
I Have A 401(k) From My Old Job. What Are My Options?
Option 1 – The easiest thing to do with a 401(k) from an old job is to leave the money where it is. Some 401(k) plans offer this feature for a minimal fee. The money still belongs to you and it will stay in the same investments you chose when you were employed.
This can be an attractive option if you like the investments in your old employer plan. Also, you retain flexibility and can move your money later if your circumstances change. And as I said…it’s the easiest. You don’t have to do anything. I have a 401(k) that’s still in my former employer’s plan, and I don’t see any reason to move it.
On the downside, it might be harder to get convenient customer service. I recently made an address change, and I needed to contact the HR person at my old company to do so. It wasn’t a huge deal, but I would rather have done it immediately online.
Option 2 – If your new employer also offers a 401(k), you should be able to roll the money from your old employer plan to your new employer plan. Again, this can be attractive if you like the investment options available. On the one hand, costs 401(k) plans often depend on the size of your company, so you could see some lower costs if you move from a smaller firm to a larger firm.
On the other hand, this option doesn’t provide as much flexibility as leaving the money where it is. Once you move money into your new employer’s plan, you’ll have to leave it there until you switch jobs again.
Option 3 – The most flexible option involves rolling your old 401(k) money into a traditional IRA. You can open a traditional IRA through an online brokerage, a bank, a credit union, or a financial advisor. An IRA will allow you the broadest range of investment choices. While a 401(k) plan will usually be limited to mutual funds or ETFs, an IRA will allow you to invest in individual stocks as well. Of course, you’ll either need to choose your own investments or pay your advisor to choose them for you.
When You Need To Move Quickly
Once you’ve decided how you want to proceed, there are two ways you can move your money from an old 401(k) into a new 401(k) or IRA. Ideally, your old 401(k) provider will send money directly to your new 401(k) or IRA provider upon your request. This would only require a phone call on your part.
The second option is trickier. It involves your old 401(k) provider sending a check to you, which you then need to forward to your new provider. Here’s where the need for promptness arises. If you receive a check from your old 401(k) provider, the IRS requires you to deposit it into a new 401(k) or IRA within 60 days. If you fail to do so, you’ll owe taxes on the amount you received. You’ll also face a 10% penalty if you’re under 59 ½.
These consequences can be costly.
For example, let’s say you’re in the 22% tax bracket and you want to transfer $50,000 from an old employer 401(k) into a Traditional IRA. The custodian from your old plan cuts you a check, but you don’t deposit the money in time. You’re now on the hook for a 22% tax bill and a 10% penalty.
The result? Your $50,000 just shrank to $34,000 because of your delay. You’ll need a 47% investment return before you’re back to $50,000. If your investments return 7% a year, it will take you 66 months to break even.
Like I said…it pays to be prompt.
Other Issues To Consider
401(k)s and IRAs have different rules. For example, you can withdraw $10,000 of IRA money to use as a first-time homebuyer. A 401(k) doesn’t allow that option. Similarly, you can pay for qualifying educational expenses from your IRA…but not from a 401(k).
On the flip side, putting money in a Traditional IRA could limit your ability to contribute to a Roth IRA down the line. If you make too much money to contribute to a Roth IRA through the normal method, having money in a Traditional IRA could make part or all of your “backdoor Roth” contributions taxable. Having money in a 401(k) wouldn’t have that effect.
Want Help Deciding Which Option You Should Choose?
Decisions like these can be tricky and confusing, even before you add in the stress of doing it all on a deadline. The best choice for you will depend on your specific situation. Fortunately, financial planners help clients make 401(k) decisions all the time. If you have questions about your own situation, our team of planners would be happy to help you out. Click the button below to contact us, and someone will get in touch with you!