BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

Key Question For Millennial Job-Switchers: What To Do With Your Old 401(k)?

This article is more than 9 years old.

If you are even a few years into your career and have taken any interest in saving for retirement you've surely heard this advice: stash at least enough in your 401(k) to snag your employer’s match. Good advice, and maybe you've taken it. But even if you haven't paid any heed, you might have money in a 401(k) anyway because your employer has instituted "automatic enrollment" ---meaning money is deducted from your paycheck for retirement savings unless you specifically opt out of contributing.

So purposely or not, you've funded a 401(k) with some of your hard-earned dough. Now, what do you with that 401(k) when you leave the company? The money you've put into any 401(k) is yours to keep, as are employer matching funds that "vested" during your tenure with a firm. But it is your responsibility to keep track of that money as your financial situation -- or your ex-employer's -- changes.

If you haven't faced this issue yet, you likely will soon. We Millennials are not chronic job hoppers as we are sometimes characterized. Yet if we follow the pattern of the late Baby Boomers (those born from 1957 to 64), we'll have held an average of 11 jobs each by the time we reach 46. And since we're starting to save for retirement younger than the Boomers did, we'll have even more accounts to keep track of.

Chantel Bonneau, a financial planner with Northwestern Mutual had one client with 13 different retirement savings account. The woman, a teacher, came to Bonneau at age 69 for help getting organized pre-retirement. She had managed to save $600,000 and to keep track of her baker's dozen, which she had collected following her husband around the country for his job, but the woman did not realize that at 70.5 she would have to start taking an annual "required minimum distribution" from her pre-tax retirement accounts or she'd face a big penalty. More than 40 years earlier she had put herself on track for a logistical nightmare.

Thanks to address changes and misspelled names it took Bonneau 18 months to consolidate the woman's accounts into two Individual Retirement Accounts -- one Roth IRA and one pre-tax. "When you actually need your money, when you are not deciding to roll it over because that's the right thing to do but because you need to start taking your money, you need a strategy," says Bonneau.

Too many people are like this woman. According to the Social Security Administration in the last decade 25 million people have left at least one defined contribution plan with an old employer. Occasionally this is a smart choice. More often than not, though, no choice is made.  Inertia or forgetfulness take the wheel, meaning millions of people have done the hard work of saving only to leave their money unattended.

Of course as a 20 or 30-something, you might figure you've got decades to get your act together and organize all your accounts. But putting off this chore can cost you big time. In fact, if you have a small account, your need to make a decision might be more urgent than for mid career folks. That's because if you have $5,000 or less in your 401(k) when you leave a company and don’t say what you want to do with the money, your old employer can legally close your 401(k) account and park the cash in a money market account in an IRA with high fees that could eat up what you've already saved. 

It doesn't have to be this way. When you leave a job you have as many as four options for your 401(k). If you've got more than $5,000 vested in the 401(k) you can intentionally keep the funds where they are (59% of employers allow all pre-retirees to stay with the plan according to the Plan Sponsor Council of America). You can also roll your old 401(k) into your new 401(k), if your new employer permits this (98% do). You could simply take the money out---a bad choice since you'll owe not only taxes but a 10% penalty. In most cases the best option is the fourth option: roll over your money into an IRA.

That's true for several reasons. One is that money in an IRA--but not a 401(k)---can be withdrawn for graduate school or the down payment on a house. (You'll still owe taxes, but not a penalty.)

The other reasons: your investment options are far broader in an IRA; if you do your homework, you are often able to invest with lower fees through an IRA; if you want help allocating your money to different investments, you have more and cheaper choices with an IRA (a relatively new and Millennial driven development); and consolidating your retirement savings in an IRA, with one provider, gives you fewer accounts to keep up with and makes it easier to see the big picture on your investments.

Investment choice? According to a survey by the Investment Company Institute and BrightScope, 401(k) plans offer access to an average of 25 investment options. With an IRA, on the other hand, you can choose among thousands of mutual funds, exchange traded funds and individual securities. (In some 401(k)s, you can use a brokerage window to invest in all these, but that adds another level of fees and complexity that's unnecessary if you simply roll to an IRA when you make a job move.)

Costs? Some 401(k)s at big companies (and the savings plan for federal employees) offer lower cost funds than you can ever get on your own. But they're the exception and if you work at a smaller company, watch out. According to a 2011 study from Deloitte/ICI the median all-in fee paid by an employee at a company with less than 100 plan participants was three times greater than the median fee paid by someone in a plan with more than 10,000 people (1.29% versus 0.43%). Moreover, companies can charge former employees administrative fees they absorb for current workers. According to Aon Hewitt about 15% of plans do so with a median fee of $25 a year. Particularly if you're interested in investing in index funds or even lower costs index ETFs, it's easy to invest for less in an IRA than a typical 401(k).

Advice? Automated investment management is available through 401(k)s, but only if your employer or plan administrator offers it and it can be more expensive. For example, the biggest outside managers of 401(k)s are Financial Engines, which charges between 0.2% and 0.6% of assets, and Morningstar, which charges up to 0.7% though some employers offer the service for free. Note that even those services are limited in their investment choices by what's offered in your plan. Automated investment advisors like Betterment, Wealthfront, SigFig and Future Advisor offer management services in IRAs for a fee of between 0.15% and 0.5% (plus underlying ETF costs). Charles Schwab will robo-manage your IRA management-fee-free in its new Intelligent Portfolios but will require you to hold at least 6% of your portfolio in cash. Motif Investing has a family of free, prepackaged ETF-like portfolios (Motifs) with the allocations designed for a specific time period and a range of risk tolerances.

"If you are in an IRA you get access to all the innovation that occurs in financial services, where in a 401(k) those things tend to move much more slowly," says FutureAdvisor founder Bo Lu.

Once you've decided to rollover into an IRA you have a few things to consider.

The big picture. For many people a new job is an opportunity to reflect. This should also be true of your finances. "Step back and take an overall household level view of your finances," suggests Lu. "Too many people think of the 401(k)-IRA rollover experience as occurring in a vacuum but it never does." Many people leave their first job very different than they started. Maybe you got married or had a kid. Maybe you moved to a new city or just have new goals. All of this will impact your financial plan.

The Roth. Contributions to traditional 401(k)s and IRAs are pre-tax, meaning that you don’t pay any income tax on contributions now, but you do pay tax when you withdraw funds in retirement. Roth accounts have the opposite structure; you pay tax now but not later. 

If you have both a pre-tax 401(k) and a Roth 401(k) avoid tax confusion by rolling the pre-tax into a pre-tax IRA and the Roth into a Roth. Note that people with Roth 401(k)s often also have pre-tax accounts because employers can only match into pre-tax 401(k)s.

If you don't have a Roth from your old job (or your new) consider funding a Roth IRA as well. Yes, put enough in your 401(k) to get your new employers match, then put your next $5,500 of retirement savings (the max you can put in an IRA annually) in the Roth. Not only will this provide some tax diversification in retirement, but as a young person there is a strong likelihood your income is going to grow and your tax rate with it. Another reason to fund a Roth IRA is that in an emergency you can withdraw your contributions (although not your earnings) without owing any additional tax. You don't have such easy access to money in a 401(k), even a Roth 401(k).

Am I a do-it-yourself-er? Chances are your 401(k) is invested in a target date fund. According to ICI and Employee Benefit Research Institute data, as of 2013, 52% of 401(k) participants in their 20s were in these funds. These age based portfolios aren't perfect but they are easy. "Target date funds have been a real win for new investors who haven't had the time to figure out: What is a large cap versus a small cap, mid cap, bond? What does all this mean? And how do I allocate to get to my goal?," says Stuart Robertson, who runs online brokerage ShareBuilder's 401(k) arm (the Capital One subsidiary also offers IRAs). Now that you are making a change, however, it may be time to consider moving beyond these funds.

(For more on the downside of target date funds see Janet Novack's, "Target Date Funds Are Setting Up Millennials For A Stock Market Shock--And Some Don't Even Know It.")

If you don't know what a large cap or bond is, and have no interest in learning, you should consider opening your IRA with one of the robo-advisors. These tech driven financial platforms will allocate your savings based on your answers to a series of questions about your goals and risk tolerance, making them arguably more personalized than a target date fund. Like a target date, a robo-portfolio will rebalance automatically and you can easily add more funds later.

If the idea of paying someone anything to manage your money seems asinine you can go with a mutual fund company or a brokerage such as Vanguard, TD Ameritrade, Fidelity, Schwab, E*Trade or Sharebuilder and allocate your money yourself.

If you go this route be smart about it --

Cash. Let's make a deal. You will invest your money. You will not forget about it during the few days it takes for your funds to hit your new account. You will not leave it all in cash. Cash loses value to inflation and earns next to nothing in a low interest rate environment like we are currently in. A lot of people make this mistake.

Moreover, when you tell your 401(k) provider that you want to rollover your account you will check the box for a "direct" rollover. This way the funds will go straight to your new provider. If you select "indirect" you will get a check from your employer with a portion withheld until tax time. If you do not deposit this check (plus funds to cover the 20% withheld) into a retirement account within 60 days you will owe taxes.

Index funds. "It is really hard for money managers, or fund managers, to beat their benchmark index and the vast majority don't," says Robertson. "Index funds tend to keep costs really low, if you think about that over the long term, every dollar saved is a dollar invested for the long term." These funds passively mirror a market index such as the S&P 500. The idea is to provide broad exposure to the market. These should be the building blocks of your DIY portfolio because they are cheaper and make diversification much easier.

Allocation. The right allocation for you is going to depend on your timeline, risk tolerance and other assets. For most young people it will make sense to have the majority of their retirement savings in stocks, which should be a mix of small and large companies from at home and abroad. The rest should be in bonds. A common rule of thumb is to subtract your age from 110 to get your appropriate stock/bond mix. Under this rule a 25 year old would have 85% stock and 15% bonds. That said stock prices fluctuate. Do not panic and sell in bad market. If you know you won't be able to do that go slightly heavier in bonds. This should keep the value more stable.

Follow me on TwitterSend me a secure tip