Question: What should I do with my 401(k) from a previous employer?
Answer: As with many financial planning questions, the answer is, “it depends.”
You have three basic options:
1. Keep the 401(k) account where it is.
If you are satisfied with the investment options and custodian in the current location of your account, you may want to leave it and just rebalance the account once or twice a year. Some 401(k) plans have many options for investments, but you should investigate to make sure that is the case.
Look at the expense ratios of the funds that are offered, and think about how your retirement fund fits into your overall Asset Allocation.
2. Move the money to your new 401(k).
Note that not all plans allow this, so you should check with your current employer’s Human Resources department to see if this is even an option.
The benefit of consolidating your 401(k) accounts is that you do not have to remember that you have an old account somewhere and try to get in touch with the company to move the assets later when you’ve lost touch with your old employer.
Moving 401(k) assets can be a hassle, as they usually require paperwork to come from the previous employer, not your current account custodian. Sometimes they require pages of the form to be notarized, sign-off by your spouse (often this signature needs to be notarized), and your previous employer’s HR department to sign the form and note the date you left their employment.
If your company has good investment options and they allow you to roll old 401(k) accounts over, this could be a good option. You are more likely to forget that you own an account if you have severed all other ties with a former employer. Don’t leave money sitting somewhere you won’t be able to benefit from it later – move the assets and keep your retirement money in a known location.
3. Move the 401(k) assets into a rollover IRA account.
Aside from leaving the account where it is, this is the next-easiest option. Moving 401(k) assets to an account you own individually at a brokerage company gives you the greatest flexibility in investing and the most control over the assets.
There is one reason why you might not want to start the transfer paperwork yet, and that is if you think that your income may rise above the IRS limits to contribute normally to a Roth IRA. If that happens, your only option to contribute to a Roth IRA is via the “back door”. Having pre-tax money (like 401(k) assets) in a Traditional IRA will dilute the benefits of a “back door” Roth contribution, so if you think that there is a good possibility that you will need to use this strategy to contribute to your Roth, you should wait to move anything to a traditional IRA.
For more on back door Roths, see our article here. If you want to move the assets to an individual IRA but not lose the benefits of future “back door” Roth contributions, you can try option 3b:
3b. Move the 401(k) assets to an IRA and then convert the IRA to a Roth IRA.
This is a multi-step process: you move 401(k) assets to an IRA, fill out paperwork to convert the IRA to a Roth IRA, and pay the tax now on the money you are moving into a Roth where it will never be taxed again. The downside is a lot of paperwork and a somewhat complex tax situation, as well as a hefty tax bill. But the upside is that you are never taxed again on the assets you moved, and you have no IRA assets, which means that you can use an IRA to make “back door” Roth contributions in the future.
Since this option is complex, you should seek advice from your tax preparer and financial advisor, if you have one.
Whichever option you choose, do not lose track of the accounts you own. If it is easier to consolidate, then do that. But if you think your income will rise and you may phase out of being able to contribute normally to a Roth IRA, it may be best to leave the money where it is, make yourself a reminder to rebalance once or twice a year, and wait until your retirement to move the assets.
Photo used under Flickr creative commons license.