Attention Generation Y, Don’t Forget to Rollover Your 401k!
January 11, 2007
Generation X Finance and Boston Gal picked up on an article yesterday that describes how people from Generation Y tend to switch jobs more frequently than ever before due to a variety of generational factors.
The extinction of pension plans and the rise of 401k plans is one of the signs of this generational shift. Due to the lack of corporate pensions and a failing Social Security System, these investment plans are key to the freedom and financial future these Gen Yers are trying to protect by switching jobs.
An article from about.com discusses different options for your 401k when you leave a job and the pros and cons of each. I’ve listed them below in the order of worst to best options, in my opinion.
Cash Out
The article talks about the drawbacks of taxes, penalties, and missing out on decades of tax-deferred capital compounding if you go with this option. The quote below pretty much sums it up
“cashing out a 401k when leaving jobs is the single most stupid decision a working individual can make”
Leave 401k with Previous Employer
Every 401k plan has some type of administration fees. If you leave your current investments behind every time you job hop, you’ll be incurring fees from each administrator, cutting into your investment returns. Plus trying to allocate and diversify with investments spread all over previous jobs could be a nightmare.
Rollover to New Employer
If you’re going to be leaving in a year anyway what’s the point. Seriously, if employment trends indicate you’ll likely be going from employer to employer this option could be a hassle. Every 401k plan has different investment options. With each new employer you’d have to refigure your diversifications and allocations based on new options, who wants to do all that work?
Rollover to an IRA
My employer offers about 30 options in my 401k, sometimes I think it would be nice to quit for a few months just so I could roll my investments over to a Vanguard IRA. In my opinion this is the preferred option. You choose where to invest your money, not your employer. With an option like Vanguard you’ll have many low-cost choices. If you do rollover to an IRA make sure you follow the rules in order to avoid penalties and fees. The article describes these rules
“Once the assets are received by the employee, they must be contributed into the new retirement plan within sixty days; this deposit is reported on IRS Form 5498.”
One other thing to note, you are limited by the government to one 401k rollover every twelve months so if you really hate your job try and stick it out for a year for the sake of your 401k 🙂
All posts by Ben Edwards
Thanks for clarifying this. I would like to think that I’m involved enough in my own future to be able to run my own IRA, but i don’t think I’m quite there yet… so 2.5 years after starting my current job, I’m going to transfer over my other 401k.
That is so true indeed, cashing out your 401k when switching jobs is the most stupid mistake one can commit, first you’ll be hit with a 10% penalty + you will owe taxes on the distributed amount. The best thing to do is to rollover to a Roth IRA. This is how a cash out transaction works if you leave your current job.
“When you leave your current employer, they will send you a check for your fully vested 401k retirement savings that you have accumulated. This is treated as a cash out transaction and your employer will be required to withhold a 20% tax amount, leaving you with only 80% of your cash. This is NOT what you want to do! Furthermore, you will be required to pay a 10% early withdrawal penalty if you are under the age of 55 and withdraw your 401k retirement savings as cash.
Source: http://www.401klookup.com/rollovers-401k.html
To avoid this cash out transaction, you must arrange for a Direct 401k rollover. Also known as a trustee to trustee 401k rollover, this rollover will instruct your old employer to make out a check in the name of your new 401k plan manager or “custodian” as they call it. This way, you will not be getting any cash. Your 401k funds will be sent to your new 401k custodian. Ask your new 401k custodian exactly how they want to receive this payment. Usually it will be like “Investment Banking Corporation, for the benefit of Peter James…”