What Should I Do With My Old 401K? Friday Q&A Series

Q.

I have just changed jobs and was wondering should I keep my 401 (k) account separate from last job and new job? Or convert it to IRA?

A.

You really have five options with an old 401K or 403B and need to choose from them based on your situation.

1) Do Nothing


If your old 401K was particularly low expense, or if there were some unique investment options such as the TIAA-CREF Real Estate Fund, a nice stable value fund, or the TSP G Fund, or if you new 401K has lousy options or high expenses, then just leave the money in your old 401K.  Usually there’s no problem with that as long as there’s more than a couple of thousand dollars in the account, but check your 401K Plan Document to be sure.  This is what I did when I left the military since the TSP not only has rock-bottom expenses, but also the very unique G Fund.

2) Roll It Over To A Traditional IRA

This can be a great option if you’re not interested in a Backdoor Roth IRA.  Most docs either ARE or SHOULD BE interested, so this probably isn’t that good of an option for a high earner.  The benefits of a traditional IRA over a 401K can include lower expenses and more investment options.  Downsides include loss of the Backdoor Roth IRA option and in some states, less asset protection than a 401K.  But if it’s a large 401K balance, your old 401K had lousy investments or high expenses AND your new 401K has lousy investments or high expenses, then this might be your best option.

Keep in mind that rules get a little more complicated if any of your 401K is a Roth subaccount.  When rolling it over to an IRA tax-deferred money goes into a traditional IRA and tax-free money goes into a Roth IRA.  I have read but have been unable to confirm in an IRS document that EARNINGS on tax-free money go into the traditional IRA unless the account has been open for at least 5 years.  Keep in mind that if you’re near retirement age, the rollover resets the 5 year period before you can take Roth distributions, so you might not want to do that.
3) Convert it all to a Roth

Sometimes its just easier to bite the bullet and pay the taxes.  This is a good option if both 401Ks suck, if the balance isn’t that big and you have money elsewhere to use for the taxes due, and you DO care about backdoor Roth IRAs.  Or perhaps you just want more Roth space for some other reason.

4) Roll it all over to the new 401K.


If you want to have the Backdoor Roth IRA option, and your new 401K is clearly better than the old one,  or if you highly value simplification of your finances, then the easiest thing to do is often to just roll the old 401K into the new one.  Keep in mind with a Roth 401K that this resets the “5 year period” to the establishment of the new Roth 401K, so be careful if doing this just before retirement.  If you have an even older 401K that you kept in the past because it was good (like my old TSP account) you could also roll it into there if the plan allows it.

5) Cash It Out

You can always take the money out, pay the taxes and penalties due, and spend it on a boat.  I told you there were 5 options, not 5 good options.  If you have a tiny balance in the 401K, this is sometimes the easiest thing to do.  I suppose if you’re over 59 1/2 and beginning to spend 401K money (perhaps only working part-time and relying on retirement money for part of your income), you might as well start 401K withdrawals now.


Comments

What Should I Do With My Old 401K? Friday Q&A Series — 9 Comments

  1. I’ve never really seen a 401k with lower fees than a Vanguard IRA list of index funds. I would just say roll it over to a traditional IRA if you make too much and then do a roth conversion. I think the expense ratio on the S and P 500 vanguard index fund is something like 0.05% which is cheaper than any fund in a 401k that I have seen.

  2. There are sometimes also fees for keeping your 401(k) with your (old) employer’s plan. I know mine has one. It’s pretty small compared to my balance now (~0.07%) and by the time I leave it would be even smaller, but it is something to consider. I have Vanguard index funds in my 401(k), but they’re all Investor Shares. I would probably roll it over either to an IRA or to the new employer’s 401(k) when I leave, depending on what funds they have available.

  3. DFD-

    Those additional expenses may pale in comparison to the extra taxes due. Sure, if you’ve only got $20K in the old 401K, the taxes aren’t too bad. But what if it’s a $400K 401K? “Just converting” that at your marginal tax rate could trigger a tax of $150K or more. If you do that conversion gradually, or in years when income is low, or just withdraw it gradually in retirement, you may pay much less in taxes, perhaps $50K. Paying an extra $100K in taxes to save 0.5% a year in investment expenses might not be wise.

  4. if you leave your job (or your job leaves you because your practice gets bought!), can you rollover 401k to non-deductible traditional IRA and then convert whole amount to Roth IRA without incurring taxes? Does it work like a backdoor contribution if I have no existing money in traditional IRA? Or would it be taxed anyhow?

  5. Graduating EM resident, who will be starting a fellowship in July where I will make 6 figures, and potentially too much to contribute to a Roth for 2015. Not married.

    My primary question is what I should do in regards to my State Retirement Fund, which my residency has been making me put money in to for the last 3 years. There’s ~17k in there now.

    Can I roll this directly in to a Roth IRA? At Vanguard, for instance. I already have ~18k in my Roth there. I understand I will have to pay taxes on that, but this is still probably the lowest tax bracket (even with half-year of fellow salary) I will be in for quite a while.

    Or should I roll it over in to an IRA? I’m less familiar with this, as I’ve been focusing on Roth’s while in residency, and am going to be mostly focusing on repaying loans aggressively for my first few years as an attending.

    Thank you for any help.

    • I don’t know the details of your state retirement fund, but you will likely have a tax bill if you move it directly to a Roth IRA. It may be better to leave it where it is and move it into a 401(k) when you become eligible for one. If you’re okay with the tax bill, then yes, this is a great year to do a conversion.

  6. Just to make sure I get it:

    Let’s say my salary for 2015 will be ~100-120k (half-residency, half-fellow w/ moonlighting, etc). I’ll roll my state retirement fund into an IRA, since I can’t roll it directly into a Roth. Then I could roll that whole sum in to a Roth, but would have to pay taxes on it? Could I also contribute to the Roth up to $5500, either directly or via Backdoor depending on my AGI?

    Thank you.

    • You may or may not be able to transfer/rollover/convert your state retirement fund directly to a Roth IRA. The IRS will let you if the plan will. Read your plan document. However, even if you have to stop in a traditional IRA momentarily prior to converting to a Roth IRA, you can still do so. Yes, you’ll have to pay taxes on any conversion.

      The Roth IRA contribution limit is totally separate. If you think you might be over the Roth IRA contribution income limit, then do it through the backdoor as a separate transaction.

      So if you had $20K in your state retirement fund, wanted to convert that to a Roth IRA, and wanted to put another $5K into a Roth IRA, you could open a traditional IRA, rollover the state retirement fund into it, contribute another $5K to it, and then convert it all. If your marginal tax rate is 25%, then you would pay about $5K in taxes on the conversion (25% of $20K + 0% of $5K.)

      Hope that helps.

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