What to do with old 401k?

With more and more employers offering 401k plans AND more and more employees changing jobs frequently; you are bound to be asking yourself the following question:

What should you do with your ‘old’ (previous employer) 401k account?

There are 5 options:

Option 1. Leave it where it is
Option 2. Roll over to new employer 401k
Option 3. Roll over to your IRA account
Option 4. Roll over to your Roth IRA account
Option 5. Cash out

A selection needs to be made keeping in mind these 5 factors:

A. Quality of investment choices in the old 401k
B. Quality of investment choices in the new 401k
C. ETF v/s stock picking
D. MAGI consideration – back door entry to Roth IRA
E. Administrative convenience – one less account

The most important factor in making the choice is the ‘quality’ of investment choices available in your old 401k plan. The below diagram visually represents the thought process:

Download the 401k Decision Tree

Here is a brief write up:

If you are will be making significantly less this year as compared to coming several years, then you should consider a Roth conversion of the 401k. It essentially amounts to paying the taxes now and having a tax-free growth here on (not paying taxes at withdrawal from the Roth account).

The next consideration is stock picking v/s ETF investing. 401k accounts do not have individual stock picking options. (I practice and preach ETF investing in general, more so for retirement purposes).

Then follows the main consideration – are the investment options available in your old 401k account good quality? By quality, I mean ‘well diversified’ and ‘low expense ratio’. Out of the dozens of 401k plans I have seen, all of them had ‘well diversified’ options but not all of them had ‘cheap options’.

If your old 401k has well diversified and cheap options, you can still transfer to new 401k (provided it is good quality) leading to one less account to manage.

Option 5 should be your last resort. You should cash out only if you cannot afford to stay invested. The disadvantages of cashing out are so huge that it demands a separate post in itself. For now, see a real life example from a 401k plan that allows ‘what-if’ analysis capabilities:

401k cash out - bad option

Also note, 401k transfer / rollover process is fairly simple so let that not be a factor in your decision.

{Note added on 12/31/2015 – one additional consideration in choosing option 1 – “leaving it is where it is” is your current 401k plan: assuming your current 401k plan isn’t the best and you are not likely to be in the same job for a long time; you might wish to keep your earlier 401k plan in place so that you can rollover the current 401k to the previous 401k once you change jobs.

This possibility of rolling over of current 401k plan to previous 401k plan is lost if you  choose options 2, 3, 4, or 5 – the previous 401k account gets closed in all these scenarios and you cannot re-open the 401k account.}

OneMoreDimeSPECIAL – Out of hundreds of articles I have read on the 401k subject, not one mentioned MAGI considerations when deciding what to do with the old 401k account.

OneMoreDime_Advanced – If you are a sophisticated investor and are concerned about not being ‘invested’ in the marekt for 10 (or so) days it takes after the stock is sold in the old plan and bought in the new account; consider buying call options on the side – this way you are covered if the market moves upwards in those 10 days.

OneMoreDimeTrivia – The name 401k comes from the section of the tax code [Internal Revenue Code Section 401 (K)] that made 401(k) plans possible.

3 thoughts on “What to do with old 401k?

  1. This is very informative. Makes it easier to understand the options that are available in the market.

    Ur flowchart made it easy to differentiate between different options of rolling over money and Roth vs traditional IRA.

    Thanks!

  2. Yes, you can have an IRA as well as a Roth IRA.

    There is no tax advantage of having multiple IRAs and multiple Roth IRAs but technically you can have as many IRAs and as many Roth IRAs as you like. (It might be helpful from an estate planning perspective; you can designate separate beneficiaries for each).

    Most people I know (including myself) have one IRA and one Roth IRA. Even though the IRA contribution limits for a particular year are combined contributions to IRA and a Roth IRA; the ways in which we savers use those tools are different.

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