Money is always in motion. I see this most often when a person leaves an employer, and it happens more than you’d think! Rarely do we see people staying at the same company for 30+ years then retiring. In fact, the average employment tenure is closer to 4 years. 

Whether you retired or are simply changing companies, you will need to make a big decision: what to do with your 401k. As simple as it may seem, there are a handful of options and they all have their unique advantages and disadvantages.

The least desirable option is to cash it out (i.e spend what’s left after taxes and penalties) unless there is a true financial hardship. It’s like robbing your future self. Therefore, I’m not going to discuss this as a true option here.

Typically the smarter options are to either keep the 401k where it is, transfer it to your new employer (if allowed), or roll it into an IRA. Here are some of the main considerations you should think about prior to deciding which route to take:

Pros of Keeping it in a 401k plan

• Investment expenses may be relatively low due to institutional pricing with the available investment options. This is not always the case, but generally.
• The plan may offer some computer-generated advice if you were inclined to manage it your self (aka being “self-directed”).
• Since a 401k is protected under ERISA law, creditors cannot access these assets. If you feel you’ll someday be sued, you can feel good knowing a 401k is typically insulated.
• If you own company stock in the 401k, there is a net unrealized appreciation (aka “NUA”) rule that can help out with capital gains on that stock.
• The plan may allow loans from the plan, should you be inclined to want to take a loan against your retirement plan.
• If you retire after age 55 (but before 59.5) you may be able to take penalty-free distributions.

Cons of Keeping it in a 401k plan

• If you leave your company they may allow you to keep it there, or they may require you to move it. A new employer may allow you to transfer it into their new 401k plan. Either way, the qualified plan would still “own” the assets. Assets may be subject to blackout periods or other constraints.
• The plan sponsor selects your available investment options, and the options may be limited. Just like a group dinner when you receive a fixed price menu – you may have some options (i.e. chicken or fish) but not much customization beyond that.
• If the company has access to human investment professionals for you, they are typically limited in the time and scope of help they can offer.
• If you want to take money out you may be limited to the number of distributions you can take per year.
• You may be subject to 20% mandatory tax withholding, if not doing a “direct rollover”.

Pros of rolling it into an IRA

• You have complete control of the funds with full access. No limitations.
• Probably the biggest “pro” of an IRA is the wide variety of investment options, not a limited menu. Do you want to buy some of the shiny new tech stock? Have at it! Most importantly, you will have access to enough investments to ensure you are properly diversified.
• You can choose to manage an IRA yourself, or have a professional manage it for you with complete flexibility. You can shop around brokerage houses as well as financial advisors.
• The investor has full flexibility in terms of taking distributions, no limits to the amount or number of withdrawals. You also have more options to withdraw without penalty, such as money for first-time home expenses and higher education (if not for yourself, maybe for kids or grandkids).
• More flexibility in beneficiary options – including having multiple beneficiaries and contingent beneficiaries.
• You can choose the tax withheld from distributions – even 0% if you’d like.
• It can make sense to simplify the handful of retirement accounts that have accumulated over the years. Many do this by consolidating them into one IRA.

Cons of rolling it into an IRA

• Investment expenses as well as advisor fees may make it a more expensive option. Depending on the setup, there may be account fees or trading fees as well.
• While you still have bankruptcy protection with an IRA, individual state law determines whether or not it’s protected from creditors. No guarantee that you are fully protected in the event of a lawsuit.
• No loans are allowed from an IRA (other than a 60 day option, which needs to understood before considering).
• There is no tax benefit for owning company stock (no “NUA” benefit).
• There might be some paperwork required, or at least a phone call needs to be made, to execute the rollover. A good advisor should help with this.
• Unless you qualify for one of the exceptions, you need to keep money in the IRA until age 59.5 to avoid 10% penalty. 

In conclusion

The above points were simplified for general reading purposes, but ultimately the decision should remain with the individual and his/her trusted professionals. With the tax law continuously changing, and other more complex strategies (Solo 401k, Roth conversions, etc) to consider, it’s probably not best to go it alone.

In general, I’d recommend not cashing it out. I’d also remind people to remain invested (aka stick to your plan). Just know that there are options, and it’s essential to evaluate each option carefully so the best decision is made for your specific needs.