401k options

Three 401k Options To Consider When Switching Jobs

You may be switching jobs to pursue better career opportunities. But did you know a job switch can also open up some excellent 401k options that give you more freedom and flexibility?

Editor’s Note: This is part seven in our series on how to invest your 401(k) account. See also:

As long as you’re working for your current employer, your 401k options are limited to whatever your plan allows.

That means you can only invest in the 401k options offered by your plan. You must pay the fees charged by your plan. And there is very little you can do to negotiate for more 401k options or better fee schedules.

But when you switch jobs, a number of new 401k options become available.

Three 401k Options You Should Consider

The money in your 401k belongs to you. And this doesn’t change even if you move to a new job.

In most cases, the investment firm that holds your 401k account will continue to manage your investments even if you’re no longer with the company.

But even though you can leave your money in the old account, doesn’t mean you should. Most of the time, you could do better by taking advantage of one of these three options.

401k Option #1: Roll Into a Traditional IRA

An IRA — or Individual Retirement Account — is simply a brokerage account that is used to save for retirement.

A traditional IRA allows you to grow your retirement funds without paying capital gains tax along the way. In addition, the capital you contribute to a traditional IRA is typically tax deductible. That means if you contribute an additional $5,000 to your traditional IRA this year, your taxable income can be reduced by $5,000.

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Best of all, a traditional IRA can be opened with just about any brokerage firm. This feature allows you to shop around and find the best brokerage that gives you exactly what you need. Whether you’re looking for low fees, better order execution, or excellent customer service, you can choose which company to use for your traditional IRA.

In some cases you can even use a specialized IRA custodian who can help you invest your IRA funds into unique opportunities such as real estate positions or private investments. As you can see, moving your 401k capital into a traditional IRA can give you a number of new opportunities to consider.

The one drawback with a traditional IRA is that you do have to pay income taxes on capital pulled out of your account. This can cut into your ability to spend money when you retire — especially if you’re in a higher tax bracket after retiring.

401k Option #2: Roll Into A Roth IRA

A Roth IRA is very similar to a traditional IRA with one major distinction:

Contributions to your Roth IRA are not tax deductible. So you do not save on your current taxes when you contribute money to your Roth IRA account. However, when you retire and begin taking distributions from your Roth IRA, your capital gains will not be taxed.

This can be an exceptional feature if you’re successful in growing your investment account. Another benefit is that you will have more cash to spend with a Roth IRA compared to a same-sized traditional IRA. That’s because all of the capital in your Roth IRA is available to spend without paying taxes first.

One of the 401k options you may want to consider when switching jobs is rolling your 401k balance into a Roth IRA. This will likely set off an immediate tax liability. That’s because you need to pay income taxes on the money that is put into the Roth IRA.

But you could consider this tax payment a worthwhile investment because once the money is in the Roth IRA, you won’t have to pay capital gains tax on any of your retirement money going forward.

Similar to a traditional IRA, you can shop around and find a brokerage that meets your needs. Just about any online or full service broker will be able to help you set up this account.

401k Option #3: Roll Into Your New 401k Plan

If you’re taking on a new job, your new employer will likely have its own 401k program. If you like the idea of holding your investments in one place, you might want to consider rolling your old IRA funds into your new 401k program.

This should be a very easy switch and your new 401k institution will be happy to walk you through the process. After all, they’re getting more of your retirement money to manage.

One word of caution here. It probably makes sense to wait a few months before moving your old 401k into your new account. You’ll want to make sure that you’re happy with the new 401k company and they way they handle your investments.

If you move your old 401k account into your new 401k program, it will be very difficult (if not impossible) to reverse this process. So make sure you’re happy with the new account before adding more capital to it.

Bottom line, I would generally prefer 401k options 1 and 2 over the third option. Having your money in an IRA just gives you so much more flexibility. But if you’re committed to keeping all of your retirement funds in one 401k account, this third option still works.

Zach Scheidt