Four 401k Rollover Strategies Explained

One of the most important decisions arising anytime you change jobs is what to do about your old 401k.  Since the average worker will change jobs several times over their career, it is crucial to devise a viable 401k rollover strategy.  In brief, there are two viable 401k rollover options (401k rollover to IRA, rollover to your new company’s 401k plan), the option of leaving your money in the old 401k plan, and cashing out (which is never a good idea).

401k Rollover Strategies

401k Rollover To IRA

The most popular and generally wisest course of action is to roll over the funds in your old 401k plan to an IRA with the mutual fund company of your choice (my choice is Vanguard).  This option gives you the greatest possible flexibility at the lowest cost, since many 401k funds carry a limited selection of costly, sub-par investment options.  Most of the major mutual fund companies, on the other hand, offer a wide variety of mutual funds in practically any asset class you could imagine from bonds to stocks, real estate to commodities.  The downside of this option is that you now have to keep track of two separate portfolios ( your IRA and new 401k) and it can sometimes become difficult to coordinate asset allocation decisions across multiple accounts at different providers.  Nonetheless, this is the choice I have made repeatedly for my own portfolio.

401k Rollover To A New 401k Plan

Some companies, particularly large ones like IBM, have excellent 401k plans.  If you are fortunate enough to land a job at one of these companies, it may make sense to rollover your old 401k into your new one.  This strategy has the advantage of keeping all your retirement funds in a single place, making your portfolio much simpler to manage.  This option is ill-advised if your new 401k plan is, like most, populated with sub-par, high-cost investment options.  I have personally never rolled an old 401k into a new one, but I would consider it given the proper circumstances.

Leave Your Old 401k Alone

Some plan custodians don’t allow this, but generally if your account satisfies some minimum balance requirement, you’ll be permitted to leave your funds in the old plan.  If you had a great 401k or just don’t feel like initiating a 401k rollover, you can always leave it alone.  The problem with this is two-fold:  first, you now have an orphan account that’s easy to lose track of and stop maintaining (i.e. re-balancing regularly) and second, you now have yet another account (with limited investment options) to somehow fit into your overall asset allocation.  Coordinating against two accounts is annoying enough;  coordinating over three can be a nightmare.

Cash Out Your 401k

Under no circumstances would I recommend you cash out your old 401k when you change jobs.  For starters, you’ll owe regular income tax on the amount you withdraw as well as an automatic 10% penalty off the top if you are younger than age 59 1/2.  Don’t shortchange your retirement:  a 401k rollover is the wiser decision.