401(k) rollover options: What to consider

Transitioning from one job to another can mean a flurry of adjustments—meeting new coworkers, filling out tax forms, selecting new health insurance. One thing you don't want to lose track of is your old 401(k).

You may not know what you want to do with those retirement funds right away, and that's OK. You'll likely have some time to think about it and make arrangements. In most cases, letting it sit with your former employer long term usually isn't to your advantage.

Get a rundown of your options and consider their benefits and drawbacks so you can more confidently decide which way forward gives your money the best chance to work harder for you.

In this article, we'll cover:

• Option 1: Roll over your 401(k) to an IRA of your choice
  
• Option 2: Roll over the old 401(k) to your new employer plan
  
• Option 3: Keep your 401(k) with your previous employer
  
• Option 4: Cash out your 401(k)
  
• What else to know about 401(k) rollover options
  
• Deciding which 401(k) rollover is right for you
  
• Investing wisely for your goals
  

IRAs are tax-advantaged individual retirement accounts that aren't tied to an employer. When you roll over a 401(k) from a previous employer to an IRA, you can use a direct rollover to move the full balance without triggering penalties or tax bills. It's also possible to cash out the funds and deposit them into an IRA yourself, although this indirect rollover route has time limits and potential tax implications. Either way, a rollover gives you the power to place your retirement investment with any financial institution you like.

IRAs can be either Roth (tax-free) or traditional (tax later). If you have a traditional 401(k), you can roll over to either type of IRA, although converting to a Roth will involve paying taxes. If you happen to have a Roth 401(k), you can't roll over to a traditional IRA, though you can roll into a Roth IRA without worrying about incurring taxes.

This option is easy to execute. Open the IRA account you want or use one you already have, and then contact your 401(k) plan administrator to set the rollover in motion.

If you take a new job with an employer that offers a 401(k), 403(b) or 457(b) plan, you can opt to have your prior employer's plan administrator roll over your funds from your old 401(k) into your new plan, if the plan document allows.

The main advantage of doing this is that you can consolidate your accumulated plan funds and continue to control your investment options for the ongoing balance in one place with the new plan.

A key drawback, though, is that if you change jobs again, you'll need to redecide if you want to move the balance, leave it or cash it out. Another potential downside is that your new employer likely has a designated 401(k) provider, and the plan details—such as investment opportunities and fees—may be more limiting and prescriptive than if you went with an IRA. You'll want to compare your new employer's plan to competitive IRA offers to choose the option that best serves your financial goals.

For this option, you would just contact your old employer's 401(k) administrator to move the funds once your new employer-sponsored retirement plan is open.

The easiest option in terms of immediate action is to leave your money in your previous employer's 401(k) plan. Not all employers allow this, but if they do and you like the structure and investment choices in your old 401(k) and the plan administrator has your updated information, you could carry on with what you have.

One potential benefit of this option is that, if life happens and you need to borrow against your retirement account, and your money stayed in your employer-sponsored plan, you may be able to take a loan on the money if the plan document allows.

However, realize that your old employer can change their 401(k) offerings at any time, including charging higher fees and limiting the investment options. You could end up with less control over your retirement money than you planned, especially if monitoring the status and activity of your old 401(k) isn't a priority.

The last option is cashing out your 401(k). This typically means paying a 10% early withdrawal tax penalty unless you've reached age 59½ or are in a situation where you're over 55 and retiring.

Cashing out your 401(k) usually triggers any taxes due on the money when it is withdrawn, so this option tends to be the most costly and least tax-efficient. Most people who choose this have a compelling reason to cash out rather than roll over to an IRA or new 401(k). Taking out money you've set aside as long-term savings also cuts off its opportunity to grow with tax advantages until you need it in retirement.

When you're trying to decide what to do with an old 401(k), it might be tempting to cash out and assume you'll eventually deposit your 401(k) funds into a new IRA or your current employer's 401(k). If you're considering an indirect transfer like this, keep in mind that you only have 60 days to deposit the check into a new 401(k) or IRA after withdrawal or it will be considered an early withdrawal, which usually comes with a 10% penalty plus a 20% withholding for indirect rollovers from 401(k) plans. Prompt deposits are key to continuing your savings strategy with an indirect transfer.

As you weigh your options, you'll want to consider certain factors before you make your choice about a 401(k) rollover after leaving a job. These include:

• Your current and future tax bracket. Many people who are currently in a lower tax bracket opt for a Roth IRA through a process known as a Roth conversion. It will result in a bit more of an income tax bill at the time, but it creates the option to withdraw from the Roth IRA tax-free in the future when your bracket might be higher. Conversely, savers who want to keep their tax burdens low now because they expect the rate to be lower in retirement may opt to roll over to a new traditional 401(k) or IRA and continue making tax-deferred contributions.
• The fee structure of each available account. If you're considering IRAs, your options are wide. Every institution offers different investments with different fees. Your choices in a 401(k) account, though, are limited to what the plan provider chosen by your employer offers. Learning about the fees and available investments in those accounts can help you decide where your funds have the strongest potential for growth.
• Risk tolerance and available investment options. Many employers choose a few mutual funds or other investment options to make available in their 401(k), which may make things simpler for you. However, simpler may not be better if your risk tolerance has you wishing you could be more aggressive with your retirement investments.

The best option for you won't necessarily be the same as it would be for anyone else. Consider your tax bracket, cash flow and unique life circumstances to help you determine your best path forward.

Taking the time to move and consolidate retirement plans might mean phone calls and emails today, but in the long term, this can cut down on penalties, fees and taxes. It can also keep your savings in investment vehicles that match your goals.

If you're not sure how to choose the right rollover option for your circumstances, a Thrivent financial advisor can walk you through the pros and cons of each option and help you find financial clarity.