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What to Do With Old 401(k)

I recently changed jobs and am deciding what to do with the funds in my 401(k) at my previous employer. As far as I can tell, I have the following options:

  • Leave the funds where they are
  • Roll the funds into:
    • my new 401(k)
    • a traditional IRA
  • Withdraw the funds, pay the appropriate income tax, and then:
    • invest them in a Roth IRA
    • invest them somewhere other than a Roth IRA (e.g., savings account, mutual fund, etc.)
    • spend like crazy

In planning for retirement, the critical comparison, it seems, is between 401(k)s and Roth IRAs – the main factor being the tax rate compared now to the tax rate when I retire. There are 35-40 years until that time, but it seems obvious (assuming a reasonable career progression) I’ll be in a higher tax bracket then as compared to now – giving a Roth IRA the edge.

Some have advised those in similar situations to mine (saving for retirement while young) to prioritize retirement savings in this manner:

  1. Take advantage of any 401(k) company-match (i.e., contribute enough to not miss out on any "free" money)
  2. Max out Roth IRA
  3. Max out 401(k)
  4. Invest in index funds and tax-managed funds

In my situation, there is no required 401(k) contribution to receive the company funds, so my first act should be to max out Roth IRAs. Then I contribute to my 401(k) until it is maxed, and then move on to the index/tax-managed funds.

See any holes in this strategy?

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I didn't see ... by VnutZ

See any holes in this strategy?

… buying PowerBall tickets in there.

I can remember something from way back when I worked for a place that had a 401k where they mentioned that if at all possible it is better to wait a few years after you retire (assuming you are younger than 70-1/2) to begin distributions on your 401k because by then you will be in a lower tax bracket.

As an update, I’ve decided to go the Roth IRA route. After talking to someone at Fidelity (1-800-FIDELITY), I found the way this is done is to rollover the old 401(k) into a "rollover IRA; – accounts setup for this very purpose. I then convert this into Roth IRA – at which point the funds are counted as income and taxed.

Here’s a blurb from www.401klookup.com that might help you out:

If the Roth IRA owner expects to be in a higher tax bracket upon retirement, it is advantageous for him to contribute maximum amounts of money towards a Roth IRA. Why? Because money being invested in a Roth IRA is taxed at the current lower tax bracket, and will not be taxed when it is withdrawn upon retirement (and when the Roth IRA owner is in a higher tax bracket). For example, consider an investor who contributes $2000 to a Roth IRA when he is in a tax bracket of 21%, and will be in a tax bracket of 33% upon retirement. This means that investor has already paid 21% x $2000 = $420 in taxes. Upon retirement if the investor wants to withdraw his funds, he would have had to pay 33% x $2000 = $660 under a Traditional IRA. However since the investor has already been taxed at his lower bracket of 21%, he would NOT have to pay taxes upon taking retirement distributions when he is in a 33% tax bracket.

2 Votes  - +
401k Rollover by Anonymous

Brandon,

You have lots of options infront of you, like the ones you listed, rolling over to new employer’s 401(k) plan or to a Roth or Traditional IRA or cashing out. However, be sure cashing out is NOT a good option as it could cost you up to 30% of your funds. Here’s how:

With a direct rollover, the check will be made out to the financial institution that holds and maintains your account. We advise NOT to instruct your old employer to make the check out in your name, as the tax consequences and penalties for doing this are severe! Here’s how. If the check is made payable to you, your former employer will be required to withhold 20% of your account value as federal withholding tax. Source: http://www.research401krollover.com/direct-401k-rollover.html

As an example, if you have $100,000 in your 401(k) that is made payable to you in a check, your employer will withhold $20,000 for remittance to the government. Thus, in order to bring your balance up to $100,000 in your new account, you will have to pay from your own pocket, an additional $20,000 within 60 days of receiving the distribution. The IRS will then return the $20,000 owed to you when you file your tax return upon correct completion of your rollover.

There is an advantage to doing this though, for isntance if you need some money for a temporary period of time (less than 60 days), than:

An indirect rollover can be useful if you require some cash as a short term loan (remember the 60 day limit). However it can be very dangerous if you use up the entire loan balance and cannot repay within 60 days, this could be a total financial disaster! Why would anyone use 60 a 401(k) rollover as a source of short term cash? Well useful examples include if you need cash to close the sale on a new house while you are in the middle of closing the sale on your old house. If you cannot repay back the loan within 60 days, you will be charged income taxes on your withdrawal and a 10% early withdrawal penalty/fee.

My prior employer has suggested making my 401K check out to Fidelity, where I plan on rolling my money into a Rollover IRA. However, my employer wants to mail the check to me with the check being made payable to FMTC (Fidelity Management Trust Company). By a check being mailed to me, will I be charged the 20% and 10% penalty fees even if the check is not made payable to me?

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