What happens a lot of the time is people will either leave their money sitting in their current 401k plan with their previous employer or cash out early simply because they do not understand how to rollover their money.  While leaving your money with your previous employer is a better choice than cashing out, if you continue to do this with each job you will have multiple accounts all over the place that are not being managed as properly as they could be. This is why participating in a 401k rollover is the smartest option to choose.

Going with a brokerage account will give you a lot more flexibility with your money over a typical 401k with your employer.  With a typical 401k you have limited options to mutual funds and index funds.  If you do not have a great understanding of investing or you are fine with the options provided to you by your employers 401k plan then this may be a good situation for you.  If you want more investment options then you will benefit from a brokerage account.  With a brokerage account you have the ability to benefit from ETF’s or Exchange Traded Funds.   ETF’s are traded like stocks and you have a lot of options to chose from, thousands to choose from.  They have low expenses and there are no investment minimums which make these an extremely attractive retirement investment.  A brokerage IRA offers a great amount of flexibility not only with ETF’s but you can also purchase mutual funds, individual stocks & bonds and in most cases CD’s.

The first thing you want to do is pick a brokerage firm to rollover your 401k into. There are a lot of financial institutions where this can be completed at, however be sure to check out various discount brokers as they tend to have trades with no or lower commission.  Do some research with various companies and find the best fit for you.  You will receive a form that will authorize the direct rollover of your funds into the newly opened account.

Of course there is a disadvantage to a brokerage IRA, despite the many benefits.  The greatest disadvantage is the cost.  When you have a brokerage account you will be charged a fee every time you place a trade with most brokers, unlike most mutual funds where they have a built-in expense ratio.  Another cost is if you decide to trade an ETF you not only pay a trade commission you also have recurring operating costs built into it. So with the flexibility comes a little bit of a price but sometimes the cost is worth it.  If you want to avoid a lot of these fees research some discount or free brokerage firms.

There are some benefits to a 401k rollover to a new employer as opposed to rolling over to an IRA.  This all depends on the options that are in your new employer’s 401k plan.  To invest in an IRA or single mutual fund in most cases you need a minimum investment.  So if you do not have a lot of money in your 401k it will be more difficult to diversify those funds. With a 401k rollover into a new employer’s 401k plan there are generally no investment minimums so it doesn’t matter the amount of money you have in your current 401k.  This means you can diversify a lot easier with a 401k and this is a big benefit!

As stated before there are some drawbacks with a 401k rollover into a new employer’s 401k investment plan.  The main drawback is that you have limited mutual fund investment options.  You are basically stuck with the investment choices that your company selected so there isn’t a lot of flexibility. You won’t have access to any of your funds unless at some point you want/need to take a loan from your 401k, if this is even permitted by your company, or your employment with the company is terminated.  Another drawback is that you could be paying higher fees with a company 401k plan as opposed to an outside plan.  Often times the smaller the company the higher the fees.  Make sure to check out all this information when you get your 401k packet.

If you decide that a 401k rollover to your new employer’s plan is the best option for you, have your current 401k plan transfer your funds directly to your new employer’s retirement plan.  Once the proper paperwork is completed your money is moved directly to your new retirement plan and the money never crosses your path. This is a pretty seamless process and you will be back on your way to growing your tax deferred retirement savings without any interruption.  Ensure that when you directly roll over your 401k funds that you are following federal rollover rules and this will ensure no federal income tax will be withheld from you. Sometimes your old retirement plan will mail you a check and it will be made payable to the custodian of your retirement plan or the trustee.  If you receive a check like this don’t stress about it.  This will still be considered a direct rollover.  You just need to get the check to the institution acting as the trustee of your new retirement plan. If you are unsure of the best option for you or have questions about a direct rollover to your new employer, consult a professional for advice.

The option I am going to talk about now is leaving your retirement investment with your previous employer.  I am going to discuss this first, rather than a 401k rollover or cash out option because when you leave your job you may not know exactly what you want to do yet.  I want you to know it is OK to leave your current investments where they are and what the rules are for doing so.  Take some time and do some research.

Depending on your companies rules (I suggest getting a copy), to keep your retirement savings in your previous employer’s retirement savings plan usually means you must have a balance of $5,000 or more. Some companies may only require that your balance was over $5,000 at any given time. The good news with this option is your money will continue to accrue tax-deferred, you still maintain control over how the money is invested among the companies’ investment options, you will continue to receive quarterly statements and if in the future you want to rollover your investments to a new employer who has a qualified plan or to an IRA you can do so without penalty. However, the drawbacks are future contributions may not be allowed or will be restricted, you may have limited access and your money is in the hands of your former employer. With some companies if you are over the plans designated retirement age or are 62 years of age or older, your previous employer may insist you take a payout.  Companies tend to do this to decrease the administrative costs.  If this situation does occur, do not fret as you still have other choices.  Unfortunately you just don’t have the luxury of leaving your money where it is at while you figure out your next move.

Leaving your money in your previous employer’s retirement savings plan is a good choice if you are unsure whether you want to cash out or participate in a 401k rollover and need some time to figure it out.  Another good reason to leave your retirement investments where they are is if you are quitting your job to start your own business.  Leaving the money in its current retirement plan could protect your retirement assets from any creditors if for some unforeseen circumstances your new business does not succeed.  Just make sure you don’t get in a habit of having a trail of old 401ks laying around with multiple previous employers.  Not only does this make it harder for you to keep track but it can also get really complicated when you do retire. If you are unsure of how to proceed with your options or still have questions it is a good idea to call a tax adviser prior to choosing your distribution option.