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What to do with your 401K after leaving your job?

If you’re one of the many tech workers who have experienced layoffs or a job change recently, you may be wondering what to do with your 401(K) account. Firstly, I strongly recommend that you do not cash out your 401(k) account. You will incur heavy penalties and taxes, and will also miss out on the potential growth of your retirement savings.

There are several good options and the optimal one for you depends on your situation and financial goals. In this post, I will explain the pros and cons of two common choices: rolling over your 401(k) to an IRA or to a new employer’s 401(k) plan

Rolling Over to an IRA:

This is generally my preferred option for most people. You can transfer your 401(k) balance to an IRA without paying any taxes or penalties, as long as you do a direct rollover (meaning the money goes directly from your old plan to your new account).

The main benefit of rolling over to an IRA is that you have more control over your investments and lower costs. Most 401(k) plans offer a limited selection of investment options, usually a mix of index funds and target-date funds. With an IRA, you can choose from a wide range of securities, including stocks, bonds, ETFs, mutual funds, and more. You can also avoid the 401(k) plan management fees that some employers charge former employees. If you work with an investment advisor, an IRA will allow them to actively manage your account. 

Rolling to a 401(K)

There are two situations in which rolling to a new 401K plan might be a better option than a rollover IRA:

  1. If you want to contribute to a Backdoor Roth it’s best to keep money out of pre-tax IRAs. Pre-tax IRAs will trigger taxes when you attempt to do a Roth conversion thanks to the pro-rata rule.
  2. If you have a small IRA balance and don’t want to deal with multiple accounts, it can be easier to roll your old 401K into a new employer. That way, you only have one account to manage and track. 

401(K) plans give greater protection from creditors and allow for loans, but I haven’t worked with clients who benefit from those features. 

In conclusion, I advise people to avoid cashing out their 401(k) account and instead roll it over to an IRA or a new employer’s 401(k) plan. Remember, the decision to roll over your 401(k) depends on your unique situation and financial goals. I recommend consulting with a financial advisor to determine which option is best for you.

Scott Caufield, CFA, CPA