Options For Your Old 401k or 403b Plan
Americans lost $7.7 billion in retirement savings in 2015, according to the National Association of Unclaimed Property Administrators.
Most of this lost money is tied up in an old 401k or 403b plan. You are likely reading this because you have an old 401k or 403b plan out there and are not sure what to do with it. Well, let's review your options (Good time to throw in the classic disclaimer - As you know I am a financial coach, not a financial adviser. Please reach out to a certified financial planner before you make any moves. This blog post is to share with you my experience in this space and also my research on this topic).
There are four basic options you have after you leave a job:
Leave the account alone, in your old employer's plan
Roll your 401(k) into your new employer's retirement plan
Roll your 401(k) into an IRA
Cash out the account
Not every option above is available to everyone, specifically the first two. You will need to check with your plan administrator to see which options are available to you. Personally, I feel the worst option is cashing out. Not only will you pay income tax and an early withdrawal penalty, you will also be missing out on the compound interest from that investment.
So which is the best option? Warren Buffett has stated several times that low cost index funds are typically the best option for most Americans. So if you are a passive investor and your previous employer allows you to leave it in their plan, assuming its invested in low cost index funds, this may be the option for you. The same theory applies to moving your previous plan into your current employer’s plan.
However, if you are like me and like to have a wide variety of investment options available to you, rolling into an IRA may be the best path for you. 401k or 403b plans generally have less investment options, whereas, rolling into an IRA gives you the option to invest in any stock, bond, ETF, or mutual fund that you want. Where can you go to rollover your money? You can go to a brokerage company such as Fidelity, Vanguard, Charles Schwab, etc. There should be no associated fees for opening an account and usually they provide incentives for you to choose them. In this option, one key thing to remember here is to request a "direct rollover". In a direct rollover, your old 401(k) provider writes a check in the amount of your balance payable to the new IRA. The provider can then send the check to the new IRA company, and you won’t be penalized (this can potentially save you thousands of dollars).
So should you transfer to a Roth or Traditional IRA? Back in 2014 when I was on Baby Step 2, I rolled over an old 403b to a Traditional IRA. Why? Because I didn't want to pay the associated taxes when converting to a Roth IRA. That's basically the difference. Contributions to Roth IRA are after tax so your investments grow tax free, whereas, Traditional IRA contributions are pre-tax, therefore you must pay income tax when you withdraw in retirement. My plan was to transfer into a Traditional IRA until I was out of debt and then convert to a Roth IRA. Here is an example from Dave Ramsey on converting a Traditional to a Roth IRA: "Let’s assume you and your spouse have $30,000 in a traditional IRA. If you convert that into a Roth IRA and it earns 12% for 30 years, without adding any additional money, your Roth IRA will be worth $2.9 million over a 30-year retirement—$476,820 more than your traditional IRA”.
In summary, there are pros and cons to each option, and aside from cashing out, none are necessarily bad choices. Be sure to evaluate your options, do your research, speak with a financial adviser and choose what you understand.