What Should I Do With My Old 401K?

What Should I Do With My Old 401K?

If you have left a former company, you should always move your old 401K into an IRA (Individual Retirement Account). There are many reasons for this, but the most important one is that your old company retains the power in your old 401K. By that, I mean that your old company can decide that suddenly your investments must change from Fidelity to Vanguard or vice-versa. They can also freeze your asset movements with little/no notice during blackout periods. In addition, you may only invest in the asset choices that your company allows you to, whereas in an IRA you have none of these aforementioned issues.

How Should I Do It?

First, find a financial advisor if you don’t have one already. If you are completely adverse to hiring a financial advisor, then look for a free or cheap account on E-Trade or Fidelity, but this will require more information than I will provide on this site. Basically, once you have a financial advisor, who you trust, they will be able to very easily set you up with the transfer paperwork necessary to move your money into an IRA. They will also be able to give you more information than I am about to provide on the type of IRA options that you have. More importantly, your 401K will likely be liquidated and put into your IRA in cash, therefore you will need to buy investments when you begin your IRA, and your new financial advisor can help you make those choices.

What Types of IRAs Are There To Choose From?

The first type is a traditional IRA. This IRA is taxed almost identically as your 401K (although there are some states where it gets slightly advantaged tax benefits, please contact a tax attorney or financial advisor for specifics in your state). If you move your old 401K into a traditional IRA, there will be no tax event that year, meaning it will not cost you anything, you will not pay any immediate taxes, and you will not begin paying taxes until you begin withdrawing the money (just as you would have in the 401K). This is the type of IRA that over 90% of people will wind up using in this scenario, but there are valid reasons for looking at the second type, which I am about to talk about.

The second option you have is rollover the old 401K into a Roth IRA. Roth IRAs are taxed at the time of the rollover. This means that if you rolled over a $20,000 401K into a Roth IRA, and your tax bracket was 15%, you would theoretically pay $3,000 of taxes in the current tax year. The reason you might want to do this is because the Roth IRA will then grow tax free rather than tax-deferred. Please take a look at the “Retirement Tools” Section where I discuss this in further detail, so that I do not provide a lot of repeat data on this site. To make a long story short, two main types of people should be interested in rolling over their 401K into a Roth IRA instead of a traditional IRA:

1. If you are younger than 40, you have the money to pay the taxes, you are not planning on removing the funds early, and you believe that your income will continue to rise throughout your working career.

2. If you will earn an unusually low amount of money in a particular year (e.g. if you got laid off, started a new business, or took a year off), you might decide to roll over the 401K and pay the taxes at a very low tax bracket, rather than waiting until retirement when tax rates or your income may rise from today’s date.

Retirement Junkie is a website that the Hagopian Institute put together as a source for free information to help people prepare for retirement.  Please visit retirementjunkie.com, and follow MrEmergingMedia on Twitter for more retirement tips, along with other fun offerings from Todd Hagopian and the Hagopian Institute.

About Todd Hagopian (@ToddHagopian)

Todd Hagopian received his BA from Eastern Michigan University with a major in Political Science. After graduation, he worked as a Financial Advisor and a Bank Manager before returning to school. He attended Michigan State University, where he completed an MBA with a double-major in Finance and Marketing. Todd is now a Senior Product Development Manager for a Fortune 500 company. He frequently writes about business issues, social media strategy, and political issues that he finds important. Enjoy the blog!

Posted on December 11, 2011, in Investing and tagged , , , , , , , . Bookmark the permalink. Leave a comment.

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