Here are a few crazy statistics about millennials and working:
- 25% of millennials plan to switch jobs within the next year (cnbc)
- The average job length for a millennial is 3 years (recruiting.com)
- 60% of millennials are open to new job opportunities (recruiting.com)
It’s safe to say that millennials are job hoppers. We want to find the right place to call home. Somewhere that we make good money, feel fulfilled, see growth opportunities, and have leaders and mentors to learn from. I don’t see anything wrong with that at all.
However, it is important to know that job changes happen often for millennials and when you change employers there are things that need to be done. One of them being deciding what to do with your old 401(k).
I felt like this was an important topic because in the last week I have had 3 conversations with millennials who were either unsure where their old 401(k) was or if they even had one. Surprising, I know.
These conversations sparked the idea of writing about “how to handle your old 401(k).” So here’s a breakdown of the options you have once you take a new job.
1. Roll it over to your new 401(k)
Once you start your new job and are enrolled in the new plan you can simply roll over your old 401(k) into your new 401(k). It’s a pretty simple process. You just need to contact your old plan administrator and ask them to directly move the funds to your new plan (this requires paperwork usually). This direct rollover ensures you don’t owe any taxes or miss any deadlines.
You also could do an indirect rollover and have the administrator send you a check with the funds, but then you are required to deposit the funds into the new 401(K) within 60 days to avoid income tax on the balance. There is nothing wrong with this approach, it just could result in more problems if you don’t meet the deadlines. Also, there will be a 20% mandatory withholding that will occur and you need to make up those funds before finishing the rollover. This only occurs with indirect rollovers.
2. Roll it over to an IRA
Another option you have is to roll your old 401(k) into an IRA. An IRA is an individual retirement account that is similar to a 401(k) where the funds grow tax-deferred, but then you pay taxes when you take out the money during retirement in the future. The main difference between the two, besides contribution limits, is that a 401(K) is employer-sponsored whereas an IRA is individually owned.
The benefit of choosing this option is that an IRA gives you the ability to invest in whatever you want. Typically, 401(k)’s are limited in their investment options, but with an IRA that is not the case.
The downside to this is that having an IRA could stop you from being able to do a backdoor ROTH IRA strategy. This only matters for people who make too much money to contribute to a ROTH IRA directly ($139,000 for an individual and $206,000 for married and filing jointly) but still want to contribute money to the tax-free bucket that ROTH’s create. I will write a blog post in the future that talks about this strategy in more detail.
3. Roll it over to an IRA pay taxes and convert it to a ROTH IRA
You also have the option of rolling over your old 401(k) to a traditional IRA then paying taxes and converting it to a ROTH IRA. This strategy could be very beneficial if you are in a low tax bracket right now and you would rather pay tax today than later in the future when taxes could be higher — either because taxes go up or because you make more income and are in a higher tax bracket. This is a more complex strategy, so you should consult your tax advisor or financial advisor to see if this would be a good option for you.
When doing this approach, you do not want to have taxes withheld – it’ll be subject to a 10% penalty for distribution for those under the age of 59 ½. You will want to have the cash on hand to pay the tax bill at tax time.
The great thing about ROTH IRAs is that you will never have to pay tax again on this account which makes it so powerful.
4. Leave it at your old employer
You always have the option to leave your 401(K) at your old employer. Sometimes, if the balance is low (around $1,000) they can tell you you have to move it, but if it’s above that most times they will let you keep it there.
This could be beneficial if your new 401(K) has very few investment options and leaving it there gives you more options. But typically, it would make sense to roll it into an IRA instead of keeping it at your old employer.
5. Cash it out
This is not the strategy I would recommend to most people, but you do have the option to cash out your 401(k). The reason I don’t like this idea is that if you cash it out you will have to pay a 10% penalty for early withdrawal as well as pay income taxes on it. This results in losing a large portion of the money inside the account and you starting over at $0 in your 401(k).
There are very few situations where this would be the best approach.
As you can see, you have multiple options for what to do with your 401(k) when you switch jobs. It can be hard to determine which is the best idea for you, so consult your advisor and they will help you make the right decision.
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