Ashley Asks A Question: What is a 401(k) rollover and is it bad if I don't do it?

Welcome friends to the second installment of Ashley Ask's a Question. Where the resident finance novice (me) asks Wela COO Eddie a question that is burning on my mind. Let's get to it.

Little backdrop to this question. I hear this word "rollover" in the office all the time. I had a general sense for what it meant. The more I started sitting in on meetings, the more I started to get worried that this is something I should have done. Then I really started to panic because, real talk guys, I have a 401(k) from my first job just sitting in Vanguard and I don't think I've opened a statement in 4 years (or worked for that company in 6...)

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Gah, I know. Bad. But how bad? I had to find out!

What is a 401(k) rollover and is it bad if you don't do it?

A 401(k) rollover is different from a withdrawal. A rollover is when you move your money from the 401(k) account into another tax-advantage account. For example, if you have a traditional 401(k), meaning the money is pre-tax and growing tax-deferred, you’ll want to roll it into a Traditional IRA so that it can continue to grow tax-deferred and you won’t have to pay any taxes on the amount rolled over. Another possibility is if you've changed companies you might want to roll it over to the 401(k) provided by your new employer. On the other hand, if you withdraw the money, and deposited it into your checking account for example, then the IRS views that as income to you and you’ll be taxed on the amount at your ordinary income tax rate.

It’s not “bad” if you don’t roll your money out of the 401(k), however, it’s almost always “better” if you do. There are fees and expenses associated with a 401(k) that you won’t experience in a Traditional IRA so that’s one reason it’s better. Also, 401(k)s typically have limited investment options (think the list of mutual funds you have to choose from when you sign up for your 401(k)). In an IRA, there are very few limitations on the investments you can buy. In the case of an old employer, you are paying fees on a 401(k) you are no longer taking advantage of an an employee of that company.

Bottom line: Is it bad? No, but I'm not doing myself any favors by not rolling over.