What To Do With Your Old 401(k)

If you don’t know what to do with your old 401(k), listen up.

Guys, I am so excited about this because 401(k)s are one of the best saving tools available to Americans. In fact, it’s usually the first account where millionaires cross that elusive seven-figure status.

As a short refresher, a 401(k) is what’s known as a tax-advantaged, employer-sponsored retirement account. All that means is that contributing to a 401(k) comes with certain tax incentives and that the account is offered by your employer. Here’s the catch—when you leave that employer, you have to know what to do with the account. A lot of people mess this up, and it can cost them big time, both now and in the future.

One thing that won’t cost you big time, though, is hitting that subscribe button. In fact, it costs you nothing at all. So hit it if you haven’t already, and let’s dive in.

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Before we talk about what to do, there’s one thing that in 99.9% of situations you should absolutely not do. All right, come here—a little bit closer. A little bit closer. Do not—I repeat, do not cash it out. Don’t do it.

This may seem like a good way to get cash in hand quickly, but more likely than not, it will blow up in your face. It can cause you huge problems. For anyone under the age of 59½, cashing out a 401(k) triggers an immediate 10% penalty. And regardless of your age, you have to pay taxes on those funds. That means a huge amount of the sacrifice that you made to save those dollars is immediately evaporated—gone—reduced to atoms.

There is an exception to this rule for hardship withdrawals that meet a specific set of criteria as established by the IRS, but these situations are quite rare. And yet, 41% of employees cash out their 401(k) when leaving a job, and of those, 85% drain the entire balance—as though it were just found money.

As a financial adviser, for us that is DEFCON 1—alarm bells ringing, get-to-the-lifeboats type situation. Cashing out of a 401(k) should only be done as a last resort—a break-glass provision.

Now, you might be watching this because an old employer has cashed out an old 401(k) for you and now you’re freaking out. Are you just going to get hit with taxes and penalties just for leaving a job? The short answer is no. If a former employer does this, they’ll issue you a check called a forced plan distribution, and you have 60 days to deposit that check into an acceptable account. Don’t worry—we’re going to go over all of that in this video.

So when it comes to what you personally should do with your old 401(k), only you can make that determination. But there are a few things that you should consider.

You need to know the balance of your old 401(k). If it’s over $7,000, you can just leave it at your old employer. This can be a great option for a few reasons: it’s easy, it allows you to keep the investment options that are already in the plan if you like those options, and you don’t have to worry about consolidating the accounts or doing a rollover into a new plan.

(By the way, “rollover” is just a fancy word for transferring funds from an old 401(k) into a new eligible account—and we’ll get to that shortly.)

If the balance is less than $7,000, you’re not happy with the investment options in your old 401(k), or you’re wanting to consolidate accounts to simplify your portfolio, you’ll have to answer some questions specific to your situation.

First, if you don’t have access to a new plan, or the options in your new plan are less than ideal, rolling the funds over into an IRA will likely be the best way to go. But if you do have a new plan, and it’s one with really good options, the decision is a little more nuanced.

If this is the case, you’ll need to decide whether to roll it into your new 401(k) or into an IRA. You may lean towards the IRA if you want more flexibility and freedom with the investment options, or if you don’t want to have to worry about the rollover provisions after changing jobs in the future.

You may lean towards the 401(k) option if you’re retiring early and that’s a priority, or if you want to do backdoor Roth conversions in the future. (But that’s again for a separate video.)

And no matter which of these options you pick—401(k) or IRA—it is crucial that you actually invest the dollars.

Vanguard found that nearly 30% of 401(k) rollovers are left in cash for over a year, and those same accounts are more than likely to be left in cash for more than seven years. Think about how much money that costs you. It literally makes my skin crawl.

Even if that money had just been invested in low-cost index funds, in seven years it had the potential to double. But instead, it just sat there, collecting dust, losing purchasing power because of inflation, sitting there wondering, “Will I ever be invested again?” Don’t let that be your situation.

No matter what you’re doing with your old 401(k), if you’re starting a new job that offers a 401(k), you might also need to set up your new contribution amounts and investments. If that’s the case, please, please consider setting up your new plan contributions to get your full employer match—whatever that is. It’s free money.

According to Fidelity, one in four Americans are not getting their full employer match. That is literally a guaranteed 50—or maybe even 100%—return on your money, and yet a quarter of Americans are saying, “Nah, I’m good. I don’t like free money.” That is hogwash.

Take an active role in your finances and put your dollars to work. Get your full employer match. Invest those dollars.

If you want all of this information in one place, we have a free flowchart on how to assess your 401(k) situation at moneyguy.com/resources. Be sure to check it out.

Oh, and by the way, subscribe if you haven’t already.