What to do with your old 401(k) if you change jobs | White coat investor

I often get a question like this one that came in via email:

“Do you have any advice on what to do with a 401(k) from an old employer? It is currently with ADP and rather than moving from Insperity to my current employer, is there any benefit to moving it to another platform with better investment options?”

Changed jobs? Here’s What to Do With an Old 401(k)

Almost everyone will encounter this problem at least once during their career. You have six options for handling a 401(k) from your old job, some of which are better than others.

#1 Roll over (transfer) your old 401(k) to a traditional (rollover) IRA

For a typical American, the usual answer is to simply transfer the money to a traditional IRA. The old company wants you to do this (to reduce costs), but you probably want to do it too. That’s because you typically get better investment options and lower costs in an IRA that you can choose than in the 401(k) that your employer designs. In some states, there may be concerns about the IRA receiving less asset protection than the 401(k) in a bankruptcy situation, but that can usually be alleviated by placing it in its own separate rollover IRA.

However, most white coat investors do not want to use this method due to the pro-rata issue with the Backdoor Roth IRA process. Roth conversions are always prorated among all IRAs, so if you do the Backdoor Roth IRA process every year, you don’t want to have a balance in a traditional IRA (including one labeled rollover IRA), SIMPLE IRA, or SEP-IRA.

WCIers need a better option, at least for the tax-deferred (traditional) subaccount of the 401(k). A rollover to a Roth IRA is a great option for the Roth subaccount of the 401(k). I guess if your old 401(k) balance is so big and the old plan is so terrible that it’s worth giving up your annual Backdoor Roth IRA, it might still be worth it. Those who want more money in self-directed accounts (which you can use to buy cryptocurrencies, precious metals, private real estate, etc.) can also choose this option.

More information here:

Multiple 401(k) Lines – What to do with multiple 401(k) accounts

#2 Spend your old 401(k).

Another bad option, perhaps the worst of all, is to simply cash out the 401(k). If you do this, you will pay taxes and an additional 10% penalty. That’s a rookie move if ever there was one. But I guess if the alternative is starving or something, maybe you should just pay it forward. You may also end up in a very low tax bracket if you’ve just divorced your employer, so maybe even with that 10% penalty, the tax bill won’t be so bad. By the way, that penalty for 401(k)s goes away at age 55 if you divorce your employer, even though it exists until age 59 1/2 for IRAs. If you’re retiring early, this may work well for you if you still want to spend the entire 401(k) that year.

#3 Leave that 401(k) where it is

One option that too few consider is to just leave it where it is. Most 401(k)s allow you to leave your money there indefinitely. The company might not want to You have to do it, but if you read the plan document, it probably is allowed to do it. In my physician partnership, we can’t kick you out if you separate as long as you have at least $7,000 in the 401(k). This is usually an excellent short-term plan, and if it is a solid plan with good investments and low costs, it can even be a good long-term plan if necessary.

The main disadvantage of this plan is that it can be very difficult for some people to remember old retirement accounts. They literally forget about the old 401(k)s. Don’t do that.

#4 Roll over your old 401(k) to your new 401(k)

The best option is usually to just roll it over to your new 401(k). You may have to wait a few months or even a year before using the new 401(k), but that’s often the best play in the long run. Contact the new 401(k) (or HR at the new job) to start the process. You can almost certainly leave it long enough to qualify for placement in the new 401(k).

#5 Transfer it to a Solo 401(k)

The very best option is probably to roll over the old 401(k) into a 401(k) that you have complete control over, such as a solo 401(k). To have a solo 401(k), you must have self-employment income, but that is often the case for WCIers. Some businesses can be quite simple, such as simply consistently ‘consulting’ for pharmaceutical and other companies interested in your opinion by taking paid surveys.

More information here:

Comparison of 14 types of retirement accounts

#6 Convert it to a Roth IRA

Another option that allows you to eliminate the old 401(k) and still avoid the pro-rata problem with the Backdoor Roth IRA process is to convert the old tax-deferred 401(k) to your Roth IRA. This gives you a larger Roth IRA and more tax-free future disposable money for you or your heirs. However, there is a serious drawback. A Roth conversion is a taxable event.

Normally, you will owe tax on the entire amount converted at ordinary income tax rates AND at your current marginal tax rate or higher. If it’s a large (six-figure) 401(k), you may not be able to afford the taxes on the Roth conversion — at least without using the money in the 401(k), which isn’t ideal. However, this is a great solution for a relatively small 401(k). This can certainly be a good option for a four- or low-five figure 401(k). Most high earners can easily afford the tax bill on such a small conversion.

Here’s a chart to help you keep all these old 401(k) conversations clear.

What do you think? What did you do with your old 401(k)s and why? In retrospect, was there a better option?