Avoiding Leaky Nest Eggs, Part 2: What to Do with Old Retirement Accounts

As we discussed in our last post (“Avoiding Leaky Nest Eggs, Part 1:  Where to Turn When You Need Money Fast”), a common problem in the retirement planning world occurs when employees cash out their retirement plans after switching jobs or take loans from retirement plans and fail to pay themselves back.  This problem is known as “leakage,” and it can significantly deplete retirement savings over time, jeopardizing employees’ ability to retire comfortably.  So, how do you avoid having a leaky nest egg?  First, as discussed in Part 1, know the risks of taking loans from your retirement plan and consider the pros and cons of various options if you need a lump sum of money fast.  Second, it is imperative that you make conscientious choices regarding retirement plans from former jobs.  You have several options for what to do with those accounts, as we outline below.

Leave the funds in your former employer’s plan.  Many people default to this option since it doesn’t require any effort.  And, if your former employer plan has well-diversified, passively-managed, low-cost investment options, this might not be a bad choice.  The problem comes, however, when you switch jobs several times and have multiple old retirement plans.  At that point, it is impossible for most people to keep track of the plans and manage their investments attentively while they are working, not to mention trying to manage withdrawals in retirement and required minimum distributions (RMDs) at age 70 ½.  In the interest of simplicity (which also can help investment returns since you’ll be able to pay better attention when you have fewer accounts), you should consolidate funds into a new employer plan or a Rollover IRA if you have more than one former employer plan outstanding.  (Also, if you have a low balance in your former plan, e.g. less than $5k, the plan sponsor will often force you to roll the funds over or cash them out because the administrative costs are too high to keep open such a small account.)

Roll the funds into your new employer’s plan.  If your new employer plan has excellent investment choices (again, we define “excellence” in this regard as well-diversified, passively-managed, low-cost mutual funds), rolling over the funds into the new plan might be a good choice.  This achieves the goal of consolidation, leaving only one account for you to monitor and manage.

Roll the funds into a Rollover IRA.  If, however, you do not have excellent investment choices with your former employer plan or new employer plan–or you are starting to accumulate old employer plans and they are getting hard to manage–you may want to consider moving the funds into a Rollover IRA.  This gives you more control over your investment options, and you can consolidate multiple accounts into one IRA.  Even if you do have excellent investment choices in your old plan or new plan, but you realize that personally you are not very adept at or interested in monitoring and managing your retirement savings, you may still want to consider moving the funds into a Rollover IRA and have the account managed by a financial adviser (like us!).  Assuming that the financial adviser is a good one (like us!), this move will have the advantage of excellent investment choices as well as close management of the account, meaning that the adviser will regularly rebalance the portfolio, manage your withdrawals and RMDs, strategize how to minimize taxes when drawing on your accounts, etc.

Cash out your retirement plan.  As we hinted above, cashing out your retirement plan is our least favorite option.  Not only will you likely face income tax and a 10% penalty on the withdrawal (if you’re under age 59 ½), you will forego years of tax-deferred growth that would otherwise have aided your ability to retire comfortably.  However, if you anticipate needing money from your retirement account prior to age 59 ½ due to unemployment or another significant reason, be sure to consult a financial adviser on what to do with your old retirement plan, since there are some exceptions to the penalty on early withdrawals that differ between IRAs and qualified retirement plans like 401(k)s.

If you are switching jobs, please give us a call so that we can talk through the options for your old retirement plan.  We certainly hope that you won’t indulge in retirement savings leakage, but we also don’t want you to fall victim to inertia and just stick with the status quo (leaving the plan where it is) if that is not the best option for your financial future.  We can evaluate the investment options at your old plan and new plan, compare them to the investment choices at our disposal, and discuss which option might be best for you.