Changing jobs is exciting, but there are some practical things you have to deal with, like what to do with your old 401(k) plan.
You have the option of leaving your funds in your old 401(k) plan, but there are a few downsides to doing that: You can no longer contribute to it and you'll have multiple 401(k) plans floating around you need to keep track of.
It's "definitely an option," certified financial planner Nick Holeman tells CNBC Make It, "but typically, the downsides mean it's not the best option."
Here are two alternatives to leaving your money with your old company:
1. Roll over your 401(k) to your new employer's plan
Assuming your new employer's plan accepts rollovers, "this is a good option if you like the investment choices and the fees aren't too high," Holeman says. "This way, your money will all be in one account and it'll be easier to manage."
2. Roll over your 401(k) to an individual retirement account (IRA)
If you aren't happy with the investment choices offered by the new plan or the fees are high, you can move your 401(k) into an IRA or Roth IRA. This is a great alternative because IRAs "typically have lower fees and more investment choices," Holeman explains.
"They're both retirement accounts; you just get to pick when you pay the taxes," says Holeman of the difference between a traditional IRA and Roth IRA.
With a traditional IRA, you contribute pretax dollars and let that money grow tax-deferred over time. You'll pay taxes on your contributions (and investment gains) only when you withdraw the money, which you can do starting at age 59½. If you withdraw before then, you'll have to pay a penalty fee.
With a Roth IRA, contributions are taxed when they're made, so you can withdraw the contributions and earnings tax-free once you reach age 59½. There is an income cap on the Roth IRA: Only married people earning less than $189,000, or single people earning less than $120,000, are allowed to make the maximum yearly contribution of $5,500 (or $6,500 for people aged 50 or older).
"Once you know what your options are and what makes sense for you to do from an investment and fee perspective, then you actually have to execute the rollover," says Holeman.
How to move your money
You have two options when it comes to rolling over your money, a direct rollover or an indirect rollover. Holeman recommends doing a direct rollover: "When you do an indirect rollover, you're the one handling the money, so the 401(k) provider will write you a check and then it's up to you to actually deposit it into the new account. There's just more that can go wrong, so I typically recommend doing a direct rollover and let the companies handle it."
With a direct rollover, your 401(k) funds move straight to your new account and the money never passes through your hands. "You just have to fill out a form, sign it and the rest is pretty much out of your control," says Holeman.
Other things to keep in mind
- When switching jobs, you never want to withdraw the balance of your 401(k) instead of moving it. Cashing out before age 59½ incurs a 10 percent early withdrawal penalty. (An exception to this rule is if you lose or leave your job at age 55 or later. In that case, you won't have to pay the 10 percent penalty.) Plus, you'd be reducing how much money you'll have for your own retirement.
- There may be a one-time fee for doing a rollover. "Some accounts will charge a closing fee of say $50," says Holeman. "But that's like ripping off the band-aid. Of course, no one likes paying fees, but sometimes you just have to do it. Plus, most of the time, they're pretty minimal."
- There's no limit on how much 401(k) money you can transfer to an IRA. "If you're just moving accounts, it doesn't count as a contribution, so you could roll over $1 million, $2 million or $10 million in one year," says Holeman.
- To keep things as simple as possible, Holeman recommends hopping on the phone with your 401(k) provider to initiate a direct rollover. "It's the easiest way," he says.
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Video by Brandon Ancil.