This Is How We Roll - Rolling Over Your 401K After Leaving An Employer

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Ending a relationship is always tough, no matter which party you are.

If you are the person that is actually doing the ending you still feel bad. There were still emotions involved in the relationship.

For the person on the other end, it’s more of a “What?!” type reaction typically.

The last thing thought about during that period of time is what you should do with your stuff at their house or apartment.

That immediate “well, you can have my stuff” reaction sometimes occurs, but more so because it’s a time of a lot of emotions. Not because you actually want to give them anything after all this drama.

Eventually things quiet down, both sides move on, and each person gathers their belongings (typically in a somewhat cordial manner) from each other’s places.

Ending a business relationship can go this way as well. Sometimes the split is mutual, but other times one side is hurt—whether it’s the company because they now have to replace a key employee or the employee because they are now out of a job.

The main difference is that the employee is really the only one that still has belongings at the counterpart’s “house.”

Yeah, I’m talking about a 401k.

 

A quick cost-benefit seesaw

The beauty of a 401k is that they offer tons of benefits. We’ve mentioned a few of these benefits in pervious emails, but let’s recap for a second.

401ks allow you to reduce the amount that Uncle Sam can tax you by the amount that you contribute to your 401k (up to a point:  $17,500 if under 50 and $23,000 if 50 or older).

Your money grows within the 401k tax-free.  You don’t have to pay taxes on any of the money that you put in or that grow within the 401k until we withdraw the funds at 59.5.  This is the earliest we can withdraw funds.

Oh yeah, and sometimes our employer is even kind enough to give us a match or what we like to call, free money!

The benefit of not being taxed on our money and being able to have the money grow tax-deferred greatly outweigh the other benefits and also the costs.

The costs of a 401k tend to go unknown.

A 401k has multiple different costs.  They have the fund costs; which based on the 401k Averages Book for 2012, the average fund cost for small plans (50 participants) was 1.37%.

But we have other costs.  Operating expenses for the 401k have a price, and at times these are passed onto the actual participants.

There are administrative costs.  Running a 401k requires much administration.  Companies have to report information to the government and also have to keep us employees up to date on the plan and our assets.  They also have to make sure our money gets from our paycheck to our plan and is accounted for properly.  This has a cost.

Some companies even participate in revenue share.  What does this mean?  Well, the costs of some of the investments may be increased and part of the increased cost may find its way back into your employer’s pocket.

Oh, and most of the time plans have an investment manager that comes to your office.  Remember that guy who comes to the office randomly?  Sometimes you like him, other times you may stay away.  Whether you utilize his knowledge or not there is a cost for him… and you pay it.

The total cost for these expenses from that same 2012 401k Averages Book was 1.46%.  This was outside of the costs of the underlying investments.

Total costs amount to a little more than 2.8% for the 401k.  That’s not cool, but we must deal with it because the benefits outweigh these costs.

 

When you roll out… actually roll out

We have to remember that the benefits outweigh the costs of a 401k.  When we roll out of the company as an employee, the benefits of the 401k are now gone, but the costs remain.

That’s no fun.

Not only do the costs remain, but our limited number of investment options remain as well.  Yes, there are more than just 20 investment options out in the world.

The world is your oyster in terms of investments when you leave.  You can be free reign, rather than caged to the companies’ options.

Remember the high fund costs associated with 401ks?   Well, we can now control what we pay (and there are definitely lower cost options).  We could find investments options that have 1% less in fees or maybe even more.

What’s the benefit of that?  Well, it can be huge.  Over a 20-year period on $10,000, the benefit stands to be $4,622. Maybe not jaw dropping, but now look at $100,000.   The benefit of gaining one extra percent every year can amount to an extra $46,217.

What about maybe a more realistic example?

Say we have saved $25,000 in our 401k, and it’s time to move on from our current employer.  If we were able to gain one more percent every year due to decreased costs for 20 years, how much do we stand to gain?  Well, pictures are worth a thousand words.

401K chart

 

So when we roll out, we want to be sure everything rolls out with us.

 

How do you roll?

This all sounds good.  We are all rolling out, but it’s not just like gathering our group of friends and rolling into the club 10 deep.

We actually have to rely on our former employer to help us.

When an individual leaves an employer and wants to roll over their 401k, it’s best to contact the number at the top of their most recent statement a couple days after leaving (let everything settle down).

Requesting a direct rollover will allow individuals to have their money roll into an IRA.

What does this mean?  Well, an IRA is very similar to a 401k, with the exception of having an employer and also having different contribution limits.  You still get the tax advantages and also the ability to aggregate all of your old 401ks into one place.

By rolling over 401ks into an IRA, this allows for all the prior 401ks to be in one place, rather than all scattered around at your former employers.  This keeps people from forgetting about money… we don’t want that!

What happens next is crucial.  The company that was holding your 401k will send you a check for the amount that was in your 401k (sometimes you can have them send this to where you opened the IRA).  This check MUST be deposited into your IRA within 60 days of being issued.

If the check is not deposited into the account within 60 days, then you will be forced to pay taxes on the ENTIRE amount.  Again, we don’t want that!

From here it’s time to invest the money!  You can check out our “Own Your Age” (OYA) recommendations to get an idea of how to do this.  OYA

 

Now, this is how we roll

Remember that a 401k is a great benefit when you are employed by the particular employer, but it becomes less awesome when you leave them.

This will help make sure you don’t lose track of money that you have rightfully saved.  It can also lead to some cost savings that may just put you in a better position when you are ready to sip daiquiris on the beach full time!