Why Leaving Behind Your 401(k) Can Hurt You - And What To Do About It

Every year, millions of people change jobs and leave their 401(k)s behind with their former employers. This happens for many reasons. Switching jobs is a busy, stressful time for most of us, so it’s often easier to just do nothing and leave your old account where it is. Even if you want to transfer your 401(k) to a new retirement account - technically called a rollover - it can be a tedious process.

All of this leads to some staggering numbers. As of 2021, there are an estimated 24.3 million forgotten 401(k)s sitting in old 401(k) plans holding over $1.3 trillion in assets. Those accounts - with an average balance of $55,000 - could be foregoing as much as $700,000 in additional savings as a result of leaving their 401(k)s behind in higher-fee, low-return 401(k)s. 

This issue is only becoming more widespread as people change jobs more frequently; the average person changes jobs every three years, meaning they have to decide what to do with an old 401(k) every few years. Over the course of a career, a typical person might accumulate twelve 401(k)s. That’s a lot of accounts to worry about! 

So, let’s review your options. 

What can you do with your old 401(k)?

When you leave a job, you won’t be able to make contributions to that 401(k) anymore. 

Roll your old 401(k) over to an individual retirement account (IRA) or another 401(k) 

For many people, moving an old 401(k) to an IRA is an attractive option. IRAs are very similar to 401(k)s with some key differences; IRAs belong to you without being connected to an employer. They also may have lower fees and more investment choices than a 401(k). Rolling over to an IRA gives you the opportunity to pick the IRA provider (think Fidelity, Wealthfront, SoFi, etc.) that best suits your needs. You’ll also be able to choose one with transparent fees that make sense for you. 

In some cases, you might be able to roll your 401(k) into your new employer’s 401(k) plan, but this depends on the plan and can be administratively complex. 

Leave your old 401(k) behind in your old employer’s plan 

You can leave your assets in your old 401(k) if you like your old 401(k) plan’s investments and fees. Keep in mind, however, that you won’t be able to make any more contributions to this 401(k) going forward. In addition, most 401(k)s have fewer investment options than IRAs and often charge higher annual fees as well. One important note: If your account balance is less than $5,000, your employer is allowed to move your assets to what is called a Safe Harbor IRA without your permission; these IRAs often charge higher fees and put your money in low-return investments. So, if your account has less than $5,000, you should consider doing a rollover to avoid this outcome.

Cash out your old 401(k)

Finally, you’re allowed to cash out your old 401(k), but this is almost always a poor choice if you’re under the age of 59 ½. First, as with any 401(k) withdrawal, you’ll have to pay income tax since your contributions were pre-tax. Secondly, if you’re younger than 59 ½, you’ll also pay a 10% penalty on top of that income tax. Depending on your income and where you live, that could mean you pay around 40% in taxes and penalties when you cash out your 401(k). As a result, most financial advisors strongly advise against this option unless you really need the cash today. 

The benefits of doing a 401(k) rollover to an IRA 

Of these three choices, rolling over your 401(k) to an IRA is often a smart financial decision for a few reasons: 

An IRA is yours, not your employer’s 

An IRA is your account and is not linked to your employer. This means you won’t have to worry about what happens to your account if and when you change jobs again in the future or retire. Plus, you can continue to contribute regardless of your employer or employment status. 

Know where you stand financially by consolidating your assets 

It’s a lot easier to know where we stand financially when our money is consolidated in one or two places instead of spread out across many accounts. You’ll be well on your way to knowing if you’re on track for retirement without having to check many accounts. This also makes it much easier to make sure your investments are properly allocated for your financial goals; instead of having to check, say, six or even twelve accounts, you only have to review one, and you’re all done.

Pick the IRA plan that works best for you 

When you decide to roll over to an IRA, you get to decide which IRA provider will get your business. You choose the provider with the right features, investment choices, and fees to suit your financial goals. That could be a roboadvisor IRA that makes investments for you, or a self-directed IRA where you pick the investments. And, of course, you can pick an IRA with the fees that suit your budget (some IRAs even charge zero fees). This is different from a 401(k) since your employer has all the power in choosing a 401(k) provider, the available investments, and the yearly fees.

How to do a 401(k) rollover - the easy way 

Historically, 401(k) rollovers have been daunting - you might have to make phone calls, complete complicated forms, mail checks via snail mail, and sometimes even get documents notarized. There is good news, though; Capitalize offers a new service that can manage your 401(k) rollover from start to finish, for free. They’ll help you find your 401(k), choose an IRA if you don’t already have one, and move your money to your new account through their online process and white glove service. They’ve helped many people consolidate their retirement accounts and avoid all the pain and hassle of going it alone.