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What Should You do With Your 401k From a Previous Job?

There are many things to consider when leaving a job, whether planned or unplanned, including deciding what to do with your current 401k. What’s the best way to manage that money? There are four options to choose from, the best one for you depends on your personal financial situation. 

1. Leave it with the old employer's plan

If you have more than $5,000 in your old employer's 401(k) plan, you might want to leave it where it is. You won't owe taxes on it until you withdraw from the account, and there's no paperwork.

The downside to this approach is that because you will no longer be contributing to your plan, you might neglect your investments and miss growth opportunities. 

2. Do a direct rollover

A direct rollover enables you to move your 401(k) money to a new retirement account— your new employer's 401(k) or an individual retirement account, or IRA. With both types, a direct rollover saves you from paying taxes and fees. 

Direct rollover to 401(k)

If your new employer has a 401(k) and accepts rollovers, you can transfer your account funds directly into your new employer's plan. There's limited paperwork and no taxes or fees. It also gives you a bigger base of savings in your new 401(k), which is helpful if you need to borrow against it.

A disadvantage is that in general, fees and investment choices with 401(k)s are more expensive than with IRAs.

Direct rollover to an IRA

Just as with a new 401(k), you can have your old employer directly transfer your savings into an IRA. IRAs usually have more investment options than 401(k)s, and sometimes lower fees as well. An IRA could be a smart choice for someone who changes jobs a lot, because it acts as a central location for all your retirement savings over the years.

Keep in mind that an IRA doesn't give you the benefit of an employer match, which many 401(k)s do. For this reason, even if you deposit the funds from your old 401(k) into an IRA, you should participate in the retirement plan at your new job, especially if it includes an employer contribution.

3. Do an indirect rollover

An indirect rollover is when you move the money to a new 401(k) or an IRA, but instead of issuing the check to your new plan administrator, your old employer sends it to you. The main drawback here is you only have 60 days to deposit that money into a new retirement plan. If you miss that window, you'll be taxed on the entire amount. If you're under 59½, you'll also owe a 10% penalty to the IRS for early withdrawal.

In addition, your ex-employer is usually required to withhold 20% from your check to cover taxes, but you're still responsible for getting 100% of the money into your new retirement plan. If you don't, you'll owe taxes and (unless you're 59½ or older) a 10% penalty on the shortfall.

The main benefit of an indirect rollover is that you can use the money during those 60 days. This could be useful if you need a short-term cash infusion but can quickly recoup the money.

4. Take the cash

It might be tempting to cash in the 401(k) and take what's called a lump-sum distribution. However, you will owe taxes on the full amount, as well as a 10% penalty if you're under 59½.

This decision might also lose money because your initial investment won't grow through compound interest. Here's the power of compound interest: If you leave $8,000 in an old 401(k) and don't touch it, in 40 years, you'll have over $56,000, assuming an annual interest rate of 5%. Consider whether your desire for cash now is worth giving up a small nest egg.

Whichever option you choose, be thoughtful about your decision. Your retirement might seem a long way off, but the choices you make now can have a big impact on your quality of life in later years.

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