Rolling over your 401(k) is only allowed when you leave your employer. However, if you are 59½, most plans will allow you to roll over your 401(k) while still working with your employer. That being said, sooner or later, you’re bound to leave your employer and you will need to make a decision on what to do with your 401(k) plan. This also applies to other tax-deferred accounts including Thrift Savings Plans (TSP), 403(b)’s, and 457’s.
Your options are to:
- Leave it alone
- Roll it over to an IRA
- Roll it over to your new employer’s retirement plan
- Roll it over to a solo 401(k) if you are a small business owner
For most people, it is a good idea to rollover your 401(k) elsewhere unless your cost-benefit analysis says otherwise. This is because it often reduces costs and simplifies your investments.
As with most important matters, you need to keep in mind a few considerations before making this decision.
1. What are your 401(k) plan’s Administrative fees?
There are typically management fees associated with your 401(k). Most people don’t check their 401(k) regularly enough to even notice these fees. Yet these fees have the potential to eat away at your returns over time.
Two Types of Fee structures
The two most common fee structures are percentage-based fees and flat-fees.
My previous employer had a 1% administrative fee on my investments while my current employer has a $79 annual flat-fee structure.
The flat-fee structure is more expensive for those who have less money invested but become cheaper as your nest egg grows.
While the percentage-based structure is cheaper initially but becomes more expensive once your investments grow.
The break-even point for me in this example is $79,000, where $79 is equal to 1% of my investments and the 1% investment is equal to the $79 flat-fee
In this example, if I only have $39,500 invested, I would be paying a 2% administrative fee which is pretty expensive in the long-term.
If you wanted to find your break-even point for more complicated percentages, divide the flat-fee by the percentage.
Example: $79 / 0.00125 = $63,200
By knowing your fees and doing the math, you can start to figure out whether it is more fiscally sound to keep your leave your old 401(k) plan where it is, roll it over to your new 401(k) plan or roll it over to an IRA.
Tip: Just because your 401k is expensive, doesn’t mean you should disregard the thought of investing in your 401k at all. The money you save from deferring your income tax and growth on investments alone is a huge benefit that easily beats 401k fees. The case for investing in your 401k becomes stronger if you have an employer match.
2. How Expensive Are The Funds?
Expense Ratios are the management fees associated with the individual investment fund(s) you choose. They are mostly unavoidable regardless of which fund you choose.
I have seen expense ratios ranging from 0.03 % to 1.25%. My employer currently offers 16 funds through Prudential.
Initially, I was very disappointed with my options because almost every fund in that account was on the more expensive side. Fortunately, I found two index funds with an expense ratio of 0.05 and 0.04. Both of which outperformed the more expensive actively managed funds that were on the list to choose from within my 401(k) plan.
Most funds in your 401(k) plan should have no-load fees, which is like a sales charge for the transaction. If there is a front-load or back-load fee, I would choose a different fund.
One of the best things about rolling over your 401(k) to an IRA is that you have a much wider field of funds to choose from.
When you roll over money from an employer-sponsored plan to an IRA, it does not count against your IRA annual maximum contribution.
3. Did you cashout?
Unless you have been told that you won’t live past a couple of weeks. Cashing out your 401(k) is a horrible idea for most people.
Not only would you forever damage your retirement fund, but you would also get hit with a 10% penalty if you are under 59 ½. However, there are exceptions to this early-withdrawal penalty based on the rule of 55.
If you found out you made the mistake of cashing out your 401(k), you have 60 days to deposit it into a qualified retirement fund, which is essentially a rollover.
4. How Vested Are You?
The term “vested” means how much of the money in your 401(k) is yours and yours alone. Well, some may go to Uncle Sam. The money you invested and its gains are typically 100% yours meaning, its 100% vested.
Whereas, the money your employer has matched and its growth may take some time to become yours to keep.
The time it takes for it to become yours is based on your employer’s vesting schedule. The two types are described below:
My first employer had a 3-year cliff vesting schedule that I missed out on. Meaning in my first and second year, I owned 0% of what my employer matched. If I had stayed in my 3rd year, I would have owned 100% of their matching contributions plus its growth. I’m glad it was only $3,000 worth.
My current employer has a 6-year graded vesting schedule. This is what it currently looks like:
- After one year of service: 0 percent vested
- After two years of service: 20 percent vested
- After three years of service: 40 percent vested
- After four years of service: 60 percent vested
- After five years of service: 80 percent vested
- After six years of service: 100 percent vested
My current company match is only 33% of the first 4% which is better than nothing, but nothing to get too excited about.
My employer match last year was a little over $1,200 even though I maxed out my 401(k) contribution at $19,500 for 2020. Knowing the nominal value of my compensation package helps me put things into perspective when negotiating.
5. Do You Plan On Working Beyond 72 years old?
If you’re reading this blog, this is likely a hard no. That being the case, this is more of a fun fact for those many years away from traditional retirement age. If you plan on working past typical retirement age, rolling over your prior employer’s 401k into your new employer’s 401(k) plan will protect it from required minimum distributions (RMDs).
Note: RMD was increased from 70 to 72 years old on January 1, 2020, as part of the Setting Every Community Up For Retirement (SECURE) Act.
Required Minimum Distributions (RMDS)
These are distributions that the IRS imposes on tax-deferred accounts to encourage you to withdraw. If you don’t, you would be charged a 50% fee. Meaning if your RMD one year was $30,000, you would have to pay a $15,000 fee, plus you are still expected to withdraw $30,000 from your retirement account.
The benefit of rolling over an old 401(k) into a new one is that the IRS cannot impose an RMD on your current employer 401(k) plan.
When learning about this rule, I thought it would apply for small business owners as well. Unfortunately, business owners who choose to continue working past 72 and contribute to their solo 401(k) plans are still subject to RMD’s assuming they own 5% or more of the company
6. Do You Value Simplicity?
Lastly, do you value simplicity? Gone are the days where employers give pensions, so are the days where people stay at one or two places of employment throughout their entire career. That being the case, it is common for the average person to be enrolled in multiple employer-sponsored retirement plans.
It can be a headache keeping track of these accounts. Even if it is more cost-effective to keep your old employer’s 401(k) plan, rollover your 401(k) balance can provide you with some clarity and mental bandwidth. Sometimes the price of simplicity can also pay dividends of its own.
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