New year, new job — old 401(k)?
Moving retirement savings when switching jobs isn’t always top of mind. It’s one more thing on your to-do list, and frankly, many folks are flummoxed by the process. But kicking the decision down the road can set you up for a fiscal pitfall.
Think of it as retirement lost.
And while hiring has slowed in recent months, there are still plenty of people changing employers and starting new positions.
In December, employers added 216,000 jobs, according to the Bureau of Labor Statistics’ latest jobs report, a sign that the labor market remains robust. And that may continue for a while longer. In a recent survey conducted by consulting firm Robert Half, nearly 6 in 10 managers said they expect to increase the number of permanent roles in the first half of 2024.
What that means is more workers changing employers this year, which can significantly impact retirement planning.
If that’s you, pay attention. Once the new-kid nerves fade and on-ramping is done, it’s time to focus on what to do with the 401(k) or other work-sponsored retirement account, such as a 403(b) parked at your former employer’s plan.
“The Bureau of Labor Statistics estimates that people hold about 12 jobs throughout their working lives, so the odds that you’ll need to decide what to do with a 401(k) at some point are high,” Anne Ackerley, head of BlackRock’s Retirement Group, told Yahoo Finance. “It’s important to understand your options — and the tradeoffs they come with.”
Here’s the breakdown of options when you change jobs to maximize the return on your 401(k) retirement plan.
You basically have four choices.
1. Take the money and run
The first one: cash out. One in 3 workers cash out their retirement accounts when leaving jobs, according to research provided by the Women’s Institute for Secure Retirement (WISER). For workers between the ages of 20 and 30, that pops up to 41% or higher, Cindy Hounsell, president and founder of WISER, told Yahoo Finance.
Changing jobs opens the door to taking your money out of your retirement plan and spending it. But this has huge repercussions. In general, you pay tax on the distribution and a 10% penalty if you’re younger than 59 ½ per IRS rules.
I cashed out when I was 30. It’s the biggest financial misstep I ever made when considering what those savings would have added up to today. So that’s No.1: Try not to cash out.
The other three options are much more preferable.
2. Leave it behind in your old employer’s plan
“Every 401(k) plan will have its own set of rules, but one likely option is that you could leave your savings where they are in your old employer’s plan,” Ackerley said. “This ‘do nothing’ option might seem convenient in the moment, but the biggest risk is that you forget it’s there or how to access it down the line.
“It’s estimated that there are nearly 30 million forgotten 401(k)s out there. So it can happen to the best of us.”
Another downside to keeping retirement savings at a former employer, of course, is that you can’t add any more money to it. And you’re stuck investing only in that specific menu of investments.
But the truth is many workers, especially younger ones who have a small account, may not have a choice.
If you’re leaving $7,000 or less, your former employer might put the money in an individual retirement account, or IRA, in your name and invest the funds in low-yielding CDs or money market funds. If it’s under $1,000, they may just cut you a check. If they cut you a check, you don’t want that. They’re taking the taxes out, and you’re paying the penalty.
3. Move the money from your old employer’s plan to your new one
The third option is transferring your old 401(k) savings to your new employer plan. You need to talk to the plan administrator about doing a direct transfer, avoiding all taxes and penalties because you’re not taking any money out. If you like the options in the new plan, it can be a good opportunity to consolidate your retirement savings in one place.
“This can help streamline things, though you’ll want to make sure you carefully follow the plan’s transfer rules, so you don’t incur any penalties or taxes,” Ackerley said. “It’s also a good idea to look at the fees associated with both your old and potential new 401(k) when making this decision.”
A bit of promising news on this front: In November, a voluntary system that automatically moves old retirement accounts into the plan of the worker’s new employer was officially launched. The Portability Services Network matches Social Security numbers on workplace accounts, gets your approval, and shifts your savings from your former employer’s plan into your new employer’s one. Plan administrators in the network include Alight Solutions, Empower, Fidelity Investments, Principal, TIAA, and Vanguard.
4. Rollover to an IRA
The final option, often recommended by financial advisers, is to roll over balances in your old employer-sponsored retirement accounts to an IRA. You do a direct transfer to an IRA at a financial institution. The folks there will help set that up for you. And you can keep adding more dollars earmarked for retirement to it.
You, in essence, take control of your retirement savings.
“This option provides a much wider array of investment choices, such as ETFs, direct stock and bond holdings to name a few, and not just the menu of mutual funds common to 401(k)s,” Jim Colavita, a certified financial planner and managing director at GenTrust, told Yahoo Finance.
Another advantage to rolling into an IRA is the ability to then convert to a Roth IRA. The two types of accounts are taxed differently — in a Roth, the assets will grow tax-free, not just tax-deferred. “Income taxes will be due upon conversion though so savers should consult with their tax adviser about this impact,” Colavita added.
Something to remember: If you have a Roth 401(k), you need to transfer that directly to a Roth IRA, whether you already have one or open a new one. But it’s got to go into a Roth.
Fees can whittle down your future nest egg
One important caveat: That rollover advice can be costly.
Many IRAs charge higher fees than your former employer plan does — even for the same investments, research from Pew Charitable Trusts found.
That means those IRA fees chew up more of your nest egg, making it even tougher to hit your retirement goals.
“Because of the compounding effects of fees, even seemingly small investment fees can add up over time,” John Scott, director of Pew’s retirement savings project, told Yahoo Finance. “A slightly higher fee difference can have an outsized effect on your retirement savings over time.”
Rollovers are not bad by themselves and can be useful, such as for consolidating accounts from different plans, he added. “But a participant must pay attention to fees — specifically the fees of the investments in the former retirement plan versus fees of investments in an IRA.”
Employer plans often use investments that receive institutional pricing while IRA investments can be sold with retail pricing — even if it’s the same mutual fund. In 2022 Pew found annual expenses for average retail shares in mutual funds were 0.34 percentage points higher than those for institutional shares — a seemingly negligible amount.
“Although this seems like a small difference,” Scott said, “it represents about 37% higher fees.”
There are other fees, too — the cost of setting up an IRA as well as annual maintenance costs. And roughly a third of Americans use a financial adviser, who charges a fee, Scott said.
You can find help, too. The Financial Industry Regulatory Authority (FINRA), a government-authorized not-for-profit organization that oversees brokerage firms, offers an online fund analyzer that lets you compare information about different funds, including expenses. And Pew has a calculator to help you see how fees impact your retirement savings.
Of course, you might find that your new job doesn’t offer a 401(k) at all. Research shows that only around half of US workers have access to an employer-sponsored retirement savings plan.
But there are still ways to stay invested for retirement. “For instance, you can invest in a target date fund through an ETF or brokerage account,” Ackerley said. “These funds are commonly used in 401(k)s and can offer the same automated asset allocation, just in a different structure.”
To be fair, there’s no big rush.
“You’re probably drinking from a fire hose as you start a new job, and it’s okay to let things settle down a bit before making this decision,” Liz Davidson, CEO of Financial Finesse, told Yahoo Finance.