Woodstock Financial Advisor – Third Act Retirement Planning —

Best 401(k) Rollover Strategy

As we examine different options investors can choose from when rolling over their 401(k) plans, it’s important to understand that choices are in fact slim. Today,

this article will discuss four distinct scenarios and highlight the best path forward accordingly.

Cash Out

The first option is to simply take your 401(k) and cash it out. Now, in this particular case, you will be forced to pay many taxes on the money you take into your possession. You will also be penalized if you are under the age of 59 1/2, under current law. With this in mind, 401(k) cash outs are probably one of the least utilized strategies utilized by investors within our retirement planning business. We know that you can certainly do this if you so choose, but most people would rather not pay those hefty taxes and get bumped up into a higher bracket than they already occupy. Oftentimes, there’s enough money in their 401(k) to even bump them up one—or sometimes even two—full tax brackets. As such, this presents itself as a very unattractive and cost prohibitive option. Yet, it certainly remains one distinct 401(k) rollover strategy.

Leave Money In Old 401(k)

Another option is to leave your money with your former employer if you either find a new job or retire, but this comes with some risk and challenges as well—most notably, if that particular company goes out of business. With a 401(k), you would think (and hope) that you need not worry about your money remaining in safe hands if your former employer goes out of business. However, I wouldn’t recommend testing out that strategy. In my 20-plus years of helping people with financial planning, I’ve seen no good reason to do this. Doing so will also likely leave you with limited choices unless you utilize self-directed options inside your 401(k), and in that case, you probably enjoy many investment strategies to choose from anyway.

I do remember one previous client who left some sort of retirement plan with a former employer that went out of business. Given that this occurred over 15 years ago, I’m having a difficult time recalling exactly what happened; but what stuck with me is that the experience was very negative and left the client vulnerable to losing everything s(he) had. This could have been money that was in a pension or some other type of company-funded retirement plan that was not a 401(k)—admittedly, I can’t specifically recall and am certainly not comfortable putting this in writing. The crux of the matter and overall lesson is that my client lost some money in his/her previous retirement plan with a former employer. So to quickly recap, if you leave your money or 401(k) with your former employer, you are at risk of facing both limited options and/or administrative difficulties, at a minimum, if said employer goes out of business.

Rollover To New 401(k)

The next option is taking your 401(k) from your former employer and using it to enroll in your new employer’s 401(k) plan. This is often a sound strategy, or at the very least one reflecting few downsides. If you decide to move forward in this manner, you’ll likely do so with tax deferments with no need to pay taxes. Not only this, but you can also avoid penalties given that you’re not withdrawing any money.

As an aside, it’s important to remember that a withdrawal is defined as removing money from your 401(k) and keeping it in your possession for more than 60 days. Conversely, if you receive a check from your 401(k) and put the money back into another retirement plan, this is considered a rollover. However, if you fail to cash that check within 60 days of your rollover, this is considered a withdrawal — which carries a penalty of 10% if you are under the age of 59 1/2. Now, let’s go back to rolling over from your old 401(k) to your new employer’s 401(k).

As you take the money from your old employer and move it to your new employer, the big drawback I see with my clients is that their new employer’s 401(k) often comes with limited investing options. Most 401(k)s do not have thousands of options to choose from, which means that many employees would rather take the money and roll it into their own retirement account to enjoy many more choices. Yet, others choose to roll their funds over to their new employer and are thus stuck with limited investing options—something we’ve seen happen numerous times throughout the years.

IRA Rollover

The final option—and the one I believe is the most attractive to investors and employees—is to take your 401(k) and roll it into your own IRA at an outfit like Charles Schwab.

In this particular scenario, investors set up a rollover or traditional IRA. They’re in fact both one in the same at a custodian like Fidelity.

In doing so, it’s important to ensure that the IRA matches the 401(k) type. Meaning that if this is a Roth 401(k), you’ll want to roll it into a Roth IRA. Yet, most of the time, we see traditional 401(k)s rolled into traditional IRAs. The inherent advantage here is the ability to move the money to a custodian with no need to rely on the financial wellbeing of the current company you’re with. Rather, your money is now with a custodian whose sole purpose is to administrate your IRA. Another big advantage is access to a wide-ranging sea of investment options including all different types of asset classes such as foreign stocks and bonds. Beyond just US stocks and bonds, you can also leverage varied types of low-cost options that involve mutual funds and ETFs—making it much easier for you to not only diversify into different asset classes but also lower your costs. Put bluntly, you typically don’t have these options when you keep your money in a 401(k), for example, which is limited in scope. If you do roll your money into an IRA, there should be no fees to set up an account. Moreover, the investments you’ll gain access to are both much more diversified and often less expensive overall.

Beyond this, another way to lower IRA costs when working with a custodian is taking advantage of lowered transaction costs. Many discount brokers like Charles Schwab have reduced their trading fees down to almost nothing, representing yet another way to save money using your own IRA versus leaving it as-is or rolling it into another company’s 401(k) plan.

Helping people roll over their 401(k)s is something I’ve enjoyed doing for well over 20 years. Likewise, I’d be more than happy to discuss related strategies with you, outlining the best option(s) for your personal needs. If you’d like to set up a 20-minute no-cost, no-obligation phone call with me, please click on this link: https://calendly.com/thomascloud/retirement-ready-success-call. We can review your varied 401(k) rollover options and where you’d like to be in the future with respect to your own financial goals, and I can share how I’ve helped various clients achieve related successes in the past.

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