Reader Mail: What Should I Do With My Old 401(k)?

Dear MintLife:

I’m 34, with two kids and a wife that isn’t employed. I put 3-5% of my income into an employer-sponsored retirement plan and I put another few-hundred dollars monthly into a Roth IRA. I also have two 529 plans that I contribute a few thousand dollars annually.

I recently transitioned jobs and have about $20,000 in my old employer’s 401k. What should I do with it?

1) Leave the funds in the old 401(k).

2) Roll the money over into my new employer’s 401(k).

3) Roll the money over into my Roth IRA, which currently only has about $7,000 in it. I realize I need to pay taxes on the money before I can put it in there.

Which do you think is the best option?

Sincerely,

Jim C.

Matthew Amster-Burton Says:

None of the above.

It hardly ever makes sense to leave money in an old 401(k), unless it’s one of the best in the business, such as the federal Thrift Savings Plan or a 401(k) offered by a major corporation. Why not? You can get access to low-cost mutual funds or ETFs—better than you’ll find in most 401(k)s—by rolling your money over to an IRA at a major fund company like Fidelity, Vanguard, or Schwab. You will also never pay taxes or penalties when you do a rollover.

For example, if you’re looking for a US stock fund, Fidelity’s Spartan Total Market Index Fund (FSTMX) charges annual expenses of 0.10%. Very few 401(k)s offer such a cheap stock fund and cheaper is better: Many studies have found that the best way to choose a mutual fund is to look for the lowest expense ratio in its category.

In other words, if your old 401(k) is like a mediocre, overpriced restaurant, you’ll save money and eat better by cooking at home.

I asked Jim about the investment options in his current 401(k). He told me the cheapest US stock fund charges about 0.5% annually, and the cheapest bond fund charges 0.3%. That’s not bad, as far as 401(k)s go, but it’s not so good that he should roll his old 401(k) into it.

So, Jim, I’d roll the old 401(k) over into a traditional (not Roth) IRA. Jim’s family is in the 15% federal income tax bracket, which is a good place to do Roth conversions and contributions. However, there’s no hurry. If Jim converts the whole $20,000 to a Roth now, he’ll have to pay $3,000 in tax, and that money can’t come out of the converted amount; it has to come from his savings. If he rolls the $20,000 over into a traditional IRA now, he can do partial Roth conversions whenever he has the money available to pay the tax.

Get the Match

While Jim and I were discussing his investments, he found hundreds of dollars under his couch cushions.

Okay, not really, but close. Jim has been contributing about 3% of his salary to his 401(k), but while researching his investment options, he learned that his employer actually matches a portion of his contribution up to 6%. Bumping his contribution up to 6%—even if it means contributing less to his Roth IRA or 529 college savings—will give him an extra $300 next year and over $1,200 a year once he’s fully vested in the plan.

Employer match policies can be complicated, and it’s always worth double-checking to make sure you’re taking full advantage, because it’s the best return on investment you’ll ever get. (Except for investing your unconditional love in a small child…wait, I’m thinking of Hallmark’s 401(k) plan.)

Finally, Jim wondered whether he’s saving enough to retire at 65 and travel the world with his wife. For an estimate, I consulted the Getting on Track tables I wrote about recently.

Based on some rough assumptions, Jim should be saving at least 15% of his gross pay. If he bumps his 401(k) contribution up to 6%, and maxes out his Roth, he’ll be close to that. A little more savings each month, and he just might see palm trees in his future.

For the 1%

Sometimes there are reasons to leave money in an old 401(k), like if you’re a high net worth individual or highly compensated. Oh, let’s just say it: If you’re rich. Consult your financial planner for details on asset protection and the Backdoor Roth.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.