Old Employer 401K Question


#1

My husband quit his job a year ago to pursue his own business. He never contributed to his 401K for the 10 years he was with his former employer (I know, I can hear the gasps). So there’s $28,000 sitting in his old 401K doing nothing because we’re only making contributions to my 401K with my current employer. What do we do with his old 401K that’s just sitting around making about $10 a year? Cash it out and invest in index funds? Transfer it into an IRA? Leave it alone for a rainy day? I’m just not sure what’s the best move.


#2

I’d roll it into an IRA and invest in low cost index funds. With $28k you could go directly to Vanguard or Fidelity. Check out The Simple Path to Wealth by JL Collins. He talks about specific low cost index funds to invest in to get started. You can call Vanguard and they will walk you through the steps to roll over the money.


#3

Disclaimer: I’m not a professional CPA/planner/etc

Don’t cash it out as, unless you are over 59.5, that would incur penalties as well as taxes. You can do a direct rollover to a Traditional IRA w/o penalties/taxes - just make sure it is a direct rollover. Another option is to roll it into a Roth IRA, but it will be taxable income. Depending on your tax bracket/situation, it may not be much of a hit. If the new employer has a 401k, he could possibly do a rollover from the old plan to the new one.

Depending on where you live, staying in a 401k may offer some protections that IRAs don’t (such as from lawsuits/bankruptcies - but varies amongst states)

ETA: since you mentioned pursuing his own biz, I believe rollover to a SEP-IRA is also allowed.


#4

I would definitely not cash it out. You’ll have to pay taxes and the 10% penalty if he’s under 59 and a half. If it’s making $10 per year, what is it invested in? It sounds like it may be in cash, which won’t be useful over the long term.

To make the best choice you’ll need to do some research on the current 401k. Sometimes people will automatically say to roll it into an IRA, but that might not be the best option depending on your circumstances.

When leaving it in the 401k would likely be best:
-You have good, low cost investment options inside the account (like index funds)
-You need the protection from lawsuits that @SFF mentions

  • He left the company at 55 or later, in which case he may be able to take early penalty free withdrawls

When rolling it into an IRA would likely be best:
-You have high cost, bad investment options in your 401k
-You don’t need the protection from lawsuits - you’re covered by insurance
-He left the company younger than 55
-You want to be able to control the investments, or invest in options not available in the 401k

Depending upon your tax bracket, and the time you have left to go until retirement, it might be worth paying the taxes and rolling the funds into a ROTH. If your tax bracket is low because, for example, the business isn’t making much money, you might be able to do the conversion at a low tax cost. However, if your tax bracket is high, or you’re going to need the money soon, this may not be the best choice.


#5

I’d recommend moving via direct transfer to an IRA with a low cost provider like Vanguard. Investing in index funds (as you mentioned) is a great idea.

If the tax cost is reasonable (based on your marginal tax rate) and if you have some cash available, you may want to consider converting the funds to a Roth IRA. You could do so over several years to keep the tax cost down.

I would not recommend cashing it out. The tax/penalty cost is too high and you would be hurting yourself in the long run by spending retirement savings now.

John


#6

The best thing to do is do custodian-to-custodian transfer, also known as a roll-over, into an IRA. This is tax free.

You can get this done in many places, but Vanguard has the lowest fees. Call them and explain what you want to do and they will help you.