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Switching companies and don't know what to do with your 401(k)? Here are your options

Select asked Jessica MacDonald, a Vice President at Fidelity, to breakdown what your options are.

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Switching jobs can be a daunting but exciting process. Once you hand in that two weeks' notice, preparing for the switch officially begins — just make sure you save room on your to-do list for figuring out how to manage your old employer's 401(k) plan.

It's actually pretty easy to forget about your 401(k) balance. According to a study from Capitalize, a financial technology company, there are around 24.3 million forgotten 401(k) accounts in the U.S. This is money that may go completely unused if the account holders never revisit the account and make withdrawals. So, it's important to make sure that you're keeping track of old accounts when you change employers.

When it comes to managing your old 401(k) account, there are multiple options on the table.

But before you start weighing the pros and cons, make sure you jot down the login information for your 401(k) account and change the primary email address on the account to your personal email. This way, you won't lose access to the account after you've left your job.

Then, you should check with your old employer's 401(k) provider to see what their policies are when it comes to managing your account once you leave. You may have a specific time frame for making a decision, some actions may not be an option under your plan and there may be certain circumstances where you forfeit part of your 401(k) balance if you didn't stay at your company long enough for it to be fully vested.

Once you understand the policies for managing the account, you can now consider the best option for you.

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Keep it with your old employer's plan

One of the simplest things you can do with your old 401(k) account is to just leave it right where it is — this requires no further action on your end.

"Most companies allow you to do this so your money continues to grow in the investment option you selected [when you first started work at that company]," said Jessica MacDonald, the Vice President of Thought Leadership at Fidelity. And, you'll still be able to make withdrawals penalty-free once you hit age 59 1/2.

Just keep in mind, though, that if you have an account balance of less than $5,000, the account may be rolled over into an IRA.

Another reason you may opt to keep your money in your old employer's plan is if you just really liked the investment options it provided. Some employers may provide more access to certain types of 401(k) investments, like a wider range of mutual funds rather than just a target date fund.

However, there are a few potential downsides you should be aware of when deciding to go this route. For starters, you typically won't be able to make additional contributions to this plan once you switch jobs. And, the plan administrator for your old employer may charge additional fees for bookkeeping, administrative charges and legal fees to continue managing the account.

Plus, you'd have fewer withdrawal options if you were to leave your 401(k) under your old employer's plan. You may have to withdraw the full balance even if you don't need the entire amount (partial withdrawals are generally not an option when you go this route). So let's say that 401(k) balance is $20,000 and you'd like to withdraw just $10,000 — you'd wind up having to withdraw the full $20,000 even if you only need half of it. And, of course, you'd be taxed on the amount and be subject to a 10% penalty if you make the withdrawal before age 59 1/2.

And, you would be unable to take out a 401(k) loan on your balance.

So if you're happy with the investments you made in your old 401(k) plan, aren't worried if there are additional fees and don't really intend to make any withdrawals in the near future or until you reach retirement age, simply doing nothing with the account and leaving it with your old employer could seem appealing.

Roll it over into an IRA

Another option is to roll your 401(k) balance into an IRA. This could be either an existing IRA you previously opened or a new IRA. And, you can open it up at any brokerage you want (Select identified the Fidelity Investments IRA as the best account for beginners. But if you need a little extra guidance, the Betterment IRA also gives you access to a robo-advisor that can help with risk assessment and rebalancing).

Just call the brokerage where your IRA is located to get a detailed outline of what next steps would look like for completing the rollover, and call up your old 401(k) provider to ask about the process on their end. There may be forms you'll need to fill out with the details of the rollover, and you should ask if the check with the 401(k) balance will be sent to you so you can deposit it yourself or if it will be sent straight to your IRA's brokerage.

One other advantage to the rollover option is that you'll be able to make penalty-free withdrawals for a first-time home purchase or higher education expenses — even if you're under age 59 1/2. Of course, since this is a pre-tax account, you would still owe taxes on the amount you withdraw.

Rolling over your plan into an IRA means that you'll have more control over the different ways you invest your balance — you won't be limited to invest just in the funds that were offered by your old employer. You'll have thousands of investment options with many of the large brokerages, including mutual funds, index funds and individual stocks.

Just be aware that once you hit age 72, you'll have to take a required minimum distribution from a traditional IRA account even if you're still working.

This option requires a little more upfront work on your part, but in the long run, this route can provide you with more flexibility, especially when it comes to your investment choices and potential withdrawals in the near future.

Roll it over into your new employer's plan

You'll have to double check with your new employer to make sure they accept rollovers from a previous job. But if you get the go ahead to do this, you'd be able to just manage one 401(k) account rather than two different accounts potentially from two different plan providers (or even more, depending on how many past jobs you've had).

"Some people find that having just one 401(k) account makes it easier to see all their money in one place," MacDonald explained.

The money will still have the chance to grow in your new employer's plan — just make sure you like the new investment options available to you. And you'll be able to save on all the additional costs that come with just keeping your balance with your old employer.

And unlike with the IRA rollover option, you won't have to take required minimum distributions at age 72 if you move the money into your new employer's 401(k) plan.

"Ultimately, it comes down to convenience," MacDonald said. "And if you like seeing all of your assets in one place then this option could make sense."

Cash it out

And the last option, which is often not advisable, is to cash out the balance in your old employer's 401(k) account. By doing this, you would typically receive the money in the form of a check mailed to you. However, there are some serious downsides to doing this.

"Cashing out the 401(k) is an absolute last resort because there are consequences for doing this," MacDonald said. "If you do this before age 59 1/2, you'll have to pay a 10% penalty and be subject to taxes."

Fidelity actually illustrates the consequences of cashing out your 401(k) with an example on its website. Say you have a $50,000 balance in your 401(k) account and you decide to cash it out before age 59 1/2. The 10% early withdrawal penalty will amount to $5,000. Then assuming a hypothetical 7% state income tax rate, you'll pay $3,500 in taxes. And lastly, with a hypothetical 24% federal marginal income tax rate, you'll pay another $12,000 for federal taxes. This essentially means that instead of cashing out and walking away with $50,000, you'll actually be left with $29,500 after taxes and the 10% penalty fee. Plus, you'll be losing out on years of tax-free growth and compound interest from you investments.

The only circumstance where you should cash out your 401(k) is if you are in dire need of the money and have no other options. But even then, you should consider a personal loan or 0% APR credit card before you do that. Otherwise, it is generally advised to avoid cashing out and consider one of the other three options above so that your money continues to grow on a tax-deferred basis.

Bottom line

Switching companies can already be a hectic process — just don't forget to figure out what you're going to do with your old 401(k) account. The right choice will depend on your needs and whether or not you already like the investment options provided by your old employer. However, the worst thing you could do is take a backseat and not pay attention to your 401(k).

"The biggest mistake is not taking the time to weigh your options," MacDonald warned. "And another mistake is to cash out and just not take an active role."

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Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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