Leaving 401(k) Behind After Job Change Could Be Costly

We’re a nation of job hoppers.

According to the latest data from the Bureau of Labor Statistics, wage and salaried workers have been with their current employers a median of just 4.6 years. The average baby boomer, based on a group tracked beginning in 1979, held just over 11 jobs between ages 18 and 48. The kicker: Nearly half of those posts were held by age 24.

Those younger years are golden when it comes to saving for retirement, so leaving a job behind is fine, but you’d be wise to take your 401(k) with you.

The truth about 401(k) fees

We’re big fans of 401(k)s for a couple of reasons — the main one being matching dollars. You may have heard this referred to as free money, and that’s because it is. Many companies with 401(k)s offer some sort of match, ranging from 25% to 100% of employee contributions, up to a limit. The second benefit to 401(k)s is their high contribution limits: In 2016, you can kick in up to $18,000 ($24,000 if you’re age 50 or older). That limit doesn’t include matching dollars.

But these accounts aren’t without their faults: They’re often very expensive. A combination of high administrative costs for running the plan and a limited investment selection makes it tough to find competitive expense ratios when selecting your 401(k) investments. An expense ratio is the percentage of your investment that goes toward the cost of running a fund.

Compound interest means a dollar saved early on is worth much more than a dollar saved later. But the same phenomenon can work against you. Investment fees like those tied to 401(k)s are compounded over time, and the longer you pay them, the more you’ll lose. The average American couple forks over roughly $155,000 in retirement fees over a lifetime, according to public policy organization Demos, amounting to nearly a third of their investment returns.

What to do with your 401(k) when you leave a job

It’s easy to pack up your desk on your way out the door, but a 401(k) can’t be thrown in a box. Maybe that’s why nearly 30% of us leave these behind.

That’s a mistake, due not only to those fees, but also to the fact that you’ve essentially removed yourself from that account. Not only will you lose the support of the plan provider, you may not be informed about plan changes, including potential fee increases or investment options — especially if you fail to keep on top of it or you move and the old employer loses track of your information.

So what do you do with it? The best course of action, in most cases, is to roll over that 401(k) to a traditional IRA or a Roth IRA. You’ll pay taxes on the rollover to a Roth, but you’ll be able to pull money out tax-free in retirement.

Rolling over will probably save you considerable money. To figure out just how much, put your 401(k) plan into NerdWallet’s new 401(k) fee analyzer, created in partnership with FeeX. This tool can also be used if you’re staying put in your job, but you’ve already contributed enough this year to grab employer matching dollars. If your fees are on the high side, you probably want to direct additional retirement savings dollars into an IRA.

By rolling over, you’ll also spare yourself some administrative hassle, particularly if your future includes many jobs. Planning for retirement is infinitely easier when all of your money is in just one or two accounts. You’ll be able to quickly get a handle on how much you’ve saved so far, which is key to getting an accurate result from a retirement calculator.

Don’t make a 401(k) rollover mistake

To avoid a tax fiasco, you’ll want to make sure you initiate a direct rollover, rather than having a check made out to you in the amount of your account balance.

Your new IRA plan provider will be glad to walk you through the process, but in general, you’ll open the rollover IRA, then contact your old 401(k) plan provider. Give the old company that new account information and request a direct rollover. The 401(k) company will then transfer the funds or send the new provider a check for the balance.

Whatever you do, don’t take the money as cash, to be turned into a car, TV or new pair of shoes. The return on investment is bad, you’ll give up that aforementioned compounding, and you’ll owe harsh taxes and penalties for the early distribution.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: aoshea@nerdwallet.com. Twitter: @arioshea.