Hypothetically - say you've recently completed intern year and are moving onto your dream dermatology residency. Say you've been following the White Coat Money blog for a while and took our advice to start investing early. Say you pumped a small fortune into your 401k at your intern year employer. Say you would like to continue savings for your nest egg with your new employer's 401k plan. You are faced with 3 choices - leave that money with your old employer, cash it out or do a 401k rollover. What should you do?
1. DON'T cash it out!
If you cash out your old 401k and don't deposit the money in a qualified retirement account within 60 days, it not only gets taxed as regular income, you also get another 10% early withdrawal penalty added on top if you're under 59.5 years old. In short, this is the worst possible choice.
2. How about just leaving it with your old employer?
For some this may be a good choice. But you will no longer be able to contribute to it and you may find it cumbersome to manage two 401k accounts assuming you would like to continue investing with your new employer. Whether it is the better choice depends on how you answer the questions below.
3. Should you do a 401k rollover?
A 401k rollover refers to you transferring your old employer 401k funds into an IRA or your new employer 401k if it allows (uncommon). The benefits are obvious - you get to keep all your money in a tax deferred retirement account and you get to continue contributing to it. However, there are a few questions you should answer before you decide to rollover your 401k:
How does your investment options compare? Ideally your new IRA or 401k account should have just as many if not more investment options than your old account.
How much does it cost? Ideally your new investment options should cost the same or less than your old account. For example, the cost for the Vanguard S&P 500 mutual fund varies between 0.02%-0.17% depending on the account type.
How secure do you want your funds to be? Federal law protects 401k funds from most lawsuits but IRA protection is regulated by states. So if lawsuits, collections or judgements are a future concern for you, you should look up whether your state shields IRA funds from creditors.
If you transferred jobs and have an old 401k plan, you should really look into a 401k rollover. However, to make sure it will be a good financial decision by asking yourself a few quick questions. Hint: It's usually a good choice.