December 30, 2021
If you have quit a job recently, or you’re contemplating taking a break to reassess (or maybe retire), you still have one pressing job to handle-- what to do with your 401k. Here’s what I want you to consider:
Don’t Cash Out
When you leave a job, you are allowed to withdraw the money in your 401k. For younger adults, this can be tempting. You may not yet have a lot of money saved, so you figure it’s okay to use it today, rather than keep it growing.
That’s a costly mistake.
Let’s say you’re 27 and have $15,000 saved in your 401k. If you cash it out, you will owe a 10% early withdrawal penalty. If the money is in a traditional 401k, you will also owe income tax on every dollar withdrawn. If your money is in a Roth 401k, you will owe income tax on the earnings, but not what you contributed.
The bottom line is that you are going to have less than $15,000 if you cash out now. Let’s say it’s $12,000. I want you to compare that to what you could have if you leave the $15,000 growing for retirement. Assuming a 6% annualized return, you would have nearly $155,000 at age 67. If you earned an annualized 8%, your $15,000 today will be worth around $325,000. I hope that’s all the incentive you need to keep your retirement savings for retirement.
Decide Where to Keep Your 401k
If you have at least $5,000 in your 401k you will likely be able to keep the money in the plan, even though you no longer work for that employer. Leaving the money there is obviously the easiest choice. But it may not be the smartest.
I want you to check the expense ratio you are charged for the mutual funds in your 401k that you are invested in. The expense ratio is expressed as a percentage. This is the annual fee that is deducted from your account to pay the fund operator.
You should be able to find the expense ratios quickly online, by logging in to your account. If not, contact customer service and they will be able to help you. If you are paying more than 0.25%, I want you to consider moving your account to an Individual Retirement Account (IRA). Once you move your 401k money to an IRA you will be able to invest your money in index mutual funds and ETFs that charge 0.10% or less.
The less you pay in expenses, the more your money grows. I know it seems like a small amount, but keeping your money in the lowest-cost index funds or ETFs can give you tens of thousands of dollars more in retirement.
If you don’t yet have an IRA, you can open one up at discount brokerages such as Fidelity, Schwab, or Vanguard.
All the discount brokerages will help you move your money directly from your 401k into an IRA. This is called a “direct” rollover, and it means you will not owe any tax to make the move.
Credit & Debt, Saving, Investing, Retirement