Should I roll over my 401(k) into an IRA when leaving my job?

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401(k) retirement planning
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Paul Simon once famously sang about “50 ways to leave your lover,” but there must be 101 reasons why people chose to leave their job!

That puts a lot of folks into a bind: What to do with their old 401(k) when they leave?

In general, the financial services industry pushes hard to get you to roll over your 401(k) into an Individual Retirement Account (IRA). But take a moment to think it through before doing it!

RELATED: There’s a right way and a wrong way to roll over a 401(k)

A look at the great 401(k) rollover debate

When callers to The Clark Howard Show have asked Clark whether or not to roll over a 401(k) to an IRA when changing jobs, the money expert has said who the old 401(k) is with can be the deciding factor.

If it’s with a low-cost provider — like Vanguard, Fidelity or T. Rowe Price, to name just a few — Clark has historically told people to leave the money and let it grow over time.

How can he make such a blanket statement? Simple, it’s all about the expenses.

You shouldn’t be paying any more than 1% to invest and that’s the absolute ceiling. Meanwhile, it’s possible to get fees much lower than that!

Vanguard, for example, has an expense ratio of just 0.14% on its Total Stock Market Index fund. That minuscule fee is 85% lower than the average expense ratio of peer funds!

But Fidelity has Vanguard beat hands-down with its own growing family of no-fee index funds. There’s literally no cost to invest with these options. Every penny you put in goes to strengthen your financial future!

So if your 401(k) is with any of these big providers of institutional funds, you’re generally golden and shouldn’t rock the boat.

That said, here are a couple other considerations to keep in mind…

The amount of money you have may dictate the choice for you

Per the IRS, “If your account balance is less than $5,000, your employer may require you to move it.”

So if you’ve crossed that all-important $5K threshold in your 401(k) and you’re with a low-cost provider you like, you can’t be forced out.

But, on the other hand, if you have less than $5K, you could be forced out into the cold, unexpectedly needing to find a new home for your old 401(k) money.

Which brings us to our next point..

Warning: This is the #1 thing you don’t want to do with your old 401(k)!

Approximately 43% of us will treat our old 401(k) like an ATM when we leave a job, according to employee benefit plans administrator Aon Hewitt.

Bad idea!

If you do choose to cash out your 401(k), you’ll typically get hit with taxes and penalties that can eat up some 40% of your money.

Let’s say your 401(k) has a $10,000 balance and you cash it out when leaving a job. You can expect to get hit with a tax bill for 20% upfront. Then when you file your tax return the following year, you’ll face another 20% or so in taxes and penalties.

Suddenly, your $10,000 becomes more like $6,000 and you have zero saved for retirement. That’s not the kind of situation you want to find yourself in.

Consider the creditor protection piece of the puzzle

Let’s say you leave a job and have trouble finding new work. If your financial situation becomes so dire that you have to declare bankruptcy, you may wish you never rolled your old 401(k) over to an IRA.

That’s because 401(k)s enjoy unlimited creditor protection in bankruptcy court throughout all 50 states. Unfortunately, that’s not the case with IRAs.

According to NerdWallet, California, Georgia, Maine, Mississippi, Nebraska and Wyoming don’t offer full creditor protection on traditional IRAs, including rollovers.

Just something to think about because you never know what the future holds…

Play it safe: Consult with a fee-only financial advisor

We’ve outlined just a few considerations here when you’re thinking about rolling over a 401(k) at an old job to an IRA.

If you really want to get this right, you may want to hire a fee-only financial advisor to think through all the moving parts. They’re likely to come up with some angles you didn’t think of.

Garrett Planning Network offers fee-only financial planning on an hourly rate basis. Visit them online or find a member fee-only financial planner by calling (913) 268-1500.

Garrett requires any one in its network to sign a fiduciary oath. This simply means they’re duty-bound to put the best interests of the client ahead of their own interests.

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Theo Thimou About the author:
Theo has co-written several books with Clark Howard, including the New York Times #1 bestseller Living Large in Lean Times. As a single widowed parent of two young children, he strives to bring unique savings tips to men and women like him who must face life without their spouses. He can be reached at [email protected]
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