Section III-A - Lesson 9
Your 401k - Portability When You Leave
Your 401k money is usually yours for the taking when you terminate employment, and there are four things you can do with it. Any and all loans must be paid in full, as we discussed in the last lesson, before you can do any of them.
The most desirable thing you can do, under normal circumstances, is rollover your previous 401k to an IRA account that you set up with the same people that handle your regular money account. Let’s say that Vanguard is the mutual fund company that holds your regular account, and that you are investing it in the Vanguard S&P 500 Index fund. You would now open a new, separate IRA type account with them, and roll your old 401k money into this account, instructing Vanguard to purchase the S&P 500 Index fund for this account as well.
What actually occurs in this example is that you would first contact Vanguard, where you want the money to go, and set up the new IRA account. You would do the new account paperwork and also sign a “request for transfer” form, which Vanguard would forward to your old employer. You should also contact your old employer to tell them that the form has been sent, and ask if there is anything else you need to do to authorize this transfer.
What happens next is that your old company liquidates your 401k, converting it to cash. The cash is then forwarded to the new IRA custodian, and the new custodian purchases whatever fund you told them to purchase with the money they receive. The money passes from custodian to custodian without you ever touching it and all tax benefits are preserved. You incur no tax liabilities in the process.
The big advantage to rolling your account to an IRA with the people who handle your regular money account is that you wind up investing your old 401k money into the exact mutual fund that you want, while maintaining all the tax benefits of your old 401k. Presumably the reason you chose these people for your regular money was because you thought they were the best, and offered the best mutual fund for your purposes. Now you can get to invest some of your retirement account money with them as well. The only option that you lose is the ability to make a loan on this money.
There are three other, less desirable things you can do with your old 401k money when you change jobs. You can sometimes leave the money where it is, sometimes move it to your new employer, or let your old employer write you a check. All three of these options are less attractive than rolling this money to an IRA.
Why would you want to leave your money where it is, instead of rolling it to the people who hold your regular account? You have no flexibility to manage this money if you leave it where it is, and you surely should be able to find yourself a better situation.
As to moving your old 401k money to a new employer, it would be extremely unlikely, in my view, for your new employer to have a plan that would provide you with greater benefits than you could gain by rolling to an IRA with your regular money account sponsor. It’s not impossible. It’s just unlikely.
The worst thing you can do with your old 401k money is to have your old employer send you a check. You’ll be subject to full income taxes, and if you’re younger than 59 ½ you’ll be subject to the 10% penalty as well. You surely don’t want to choose this option unless you have desperate needs and nowhere else to go to get the funds.
When you retire, your choice will mainly be between leaving your money with your final employer for a while or rolling it to an IRA. Ultimately, you’ll want to roll it to an IRA for pretty much the same reasons that we discussed above.
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