5 Options for your Old 401(k)

5 Options for your Old 401(k)

April 23, 2024

                It has likely happened to all of us. We either leave a job in search of greener pastures or are laid off from a job and in the process leave an old 401(k) behind. 401(k) plans are a great way to accumulate wealth while working for an employer especially if that employer offers a matching or profit-sharing contribution. However, what are your options for your 401(k) balance once you leave the company and are no longer receiving those additional employer contributions? Well, fortunately for you, you have options! 


  1. Leave it in the old plan 

In most situations, it is perfectly acceptable to leave your 401(k) balance in the plan with your old employer. While there are some situations where an account with a very low balance will be closed (by way of sending you a check), a plan is normally perfectly happy to continue managing your money. If you decide to leave your money in the plan you will continue to be charged the applicable fees of the plan and your investment options will be restricted to those offered by the plan.


  1. Take it in cash

This is by far the least desirable option yet still worth mentioning. You do have the ability to take your 401(k) balance in cash once you leave an employer. The drawbacks to this option can be significant especially if you are younger than age 59 ½ . Because money invested in a 401(k) is invested pretax, you will be taxed on the entire portion that you withdraw from the 401(k). In addition, if you are younger than 59 ½ , the IRS will also assess a 10% penalty. For example, if you are in the 22% tax bracket and 40 years old, your withdrawal would be reduced by 32%.  On top of that, some states mandate withholding of state income tax at the time of distribution which could add an additional 4 – 5%, or more, depending on your state.  If you have been working for a company for a long time and have been diligent about investing, this could be a large hit to your retirement savings.

 

  1. Roll it into your new plan

If your new employer has a 401(k) plan, you have the option to roll your balance to the new plan. With this option, you will not be taxed or penalized however you will be assessed the fees applicable to that 401(k). Your investment options will also be restricted to those offered by the new plan. This option also allows you to consolidate your retirement savings and continue contributing to your account by way of payroll deduction.

 

  1. Roll over your account to an IRA

Of all the options mentioned, this one offers the most flexibility. Like a 401(k), a traditional IRA is funded with pretax dollars. This means that when you rollover your account balance you will not be charged taxes or penalties much like if you were to roll it into a new 401(k) plan. Unlike the 401(k), your investment options are not confined to a list of approved investments or a single fund company. You have significantly more flexibility in selecting funds or other investments that meet your needs for growth and risk tolerance. This option is best utilized when you have a financial advisor who can assist you in researching and selecting investments that will best serve your needs. In certain situations, you may be able to set up contributions by way of payroll deduction, but it is more common to contribute to an IRA by bank account transfer or check.

 

  1. Roll the balance to an HSA 

Lastly, there is a way to transfer the balance (or at least a portion of it) to a Health Savings Account or HSA. Like an IRA or 401(k), an HSA is funded with pre-tax dollars. Unlike the other two account types mentioned, an HSA has a very specific use, that is, to pay for healthcare expenses. With an HSA, contributions are deducted from your income and can be withdrawn tax free when used for qualified medical expenses. This can be particularly helpful when you have a high deductible or large long term care costs.

In order to roll money into an HSA, the funds need to first be rolled over from the 401(k) into an IRA. From the IRA, the funds can then be rolled into the HSA. The amount that you are able to rollover is capped at your annual maximum HSA contribution. For 2024, the limits are $4,150 for an individual and $8,300 if you have family coverage. If you are over the age of 55, you can contribute an additional $1,000. It is also worth mentioning that in order for this to work you are required to remain in a high deductible health insurance plan for at least 12 months post rollover. If you join a plan that is ineligible for an HSA before the testing period is over then the entire rollover will be taxable to you with an additional 10% IRS penalty. Finally, IRA to HSA rollovers are not a good idea if you are within a year of enrolling in Medicare (age 65). Rollover contributions made in that timeframe will also be disqualified and subject to taxes and penalties[i]. An IRA to HSA rollover can be done once in an individual’s lifetime.

 

As you can see, there are several options available to you should you leave a job and have a 401(k). Which option is best will depend entirely on your individual situation. There is no one size fits all approach! If you have questions about 401(k) or financial planning, you are welcome to reach out to us and we would be happy to help!

 

 

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material


[i] https://www.fidelity.com/learning-center/smart-money/ira-to-hsa-rollover#:~:text=An%20IRA%2Dto%2DHSA%20rollover%20could%20offer%20tax%2Dfree,free%20for%20qualified%20medical%20expenses.