Q&A: This forgotten account shouldn’t turn into a spending spree

Dear Liz: I just got a message about thousands of dollars I have in a 401(k) account from a job I had over 10 years ago. They are asking me what I want to do with the money, roll it over into an IRA or cash it out. What should I do?

Answer: Don’t cash it out.

Unexpected money can feel like a windfall, and it’s natural to dream about potential splurges you could afford. But this cash didn’t fall out of the sky. This is money you earned and that could grow substantially if you make the right moves now. If you cashed it out, you’d lose a substantial chunk to taxes and penalties, plus you’d lose all the future tax-deferred growth that money could earn.

Your best option probably would be to transfer the money directly into your current employer’s retirement plan, if you have one and it allows such transfers. Employer plans may offer lower-cost access to investments than you’d get with an IRA, plus consolidating the old plan into the new means one less account to monitor. Also, employer plans may offer more protection from creditors, depending on where you live.

Rolling the money directly into an IRA is another good option. You’ll need to open an account, preferably at a discount brokerage that keeps costs low. An IRA would give you access to more investment options, but beginning investors might just want to opt for a target date retirement fund or a robo-advisory service that invests using computer algorithms. With either option, the mix of investments and the risk over time would be professionally managed.

Whichever you choose, make sure the old plan sends the money directly to your chosen option, rather than sending you a check. If a check is sent to you, 20% of the money would be withheld for taxes and you’d have to come up with that amount out of your own pocket within 60 days or that portion would be considered a withdrawal that’s taxed and penalized.

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  1. The last paragraph here is false. As long as your former 401k sends you a check made out to your new financial institution (not to you specifically), there is no 20% withholding.

    The IRS website says “A distribution sent to you in the form of a check payable to the receiving plan or IRA is not subject to withholding.”

    There are a lot of financial institutions (including Fidelity) who refuse to send they money directly to a new institution, and insist on sending it via you instead. So to say that this isn’t an option is not only wrong, but affects many people.

    Source: IRS

    • Thanks, Tine. Most people wouldn’t understand the distinction and could easily make a costly mistake, so it’s better to have the money transferred directly.

  2. When I turned 59-1/2 years old (and was still working), I decided to move my 401(k) money at my employer’s financial institution into an IRA at my preferred financial institution. [After age 59-1/2, there would be no penalties for withdrawing my 401(k) funds.] First, I talked with representatives at the 401(k) financial institution and my IRA financial institution to make the arrangements for the transfer. One day, my manager walked into my office with a “big check” from the 401(k) institution, which had sent my 401(k) money to my manager (owner of small business), not to MY financial institution. I had to turn around and send the check to my IRA institution. I do not know why the 401(k) institution did not follow my instructions (to send my money to my IRA institution). They did not withhold any taxes. I am still angry when I think about this (8 years later). What if my manager had been out of the office for a few weeks? My check would have sat in her mailbox, while I was expecting it to be deposited at my IRA institution.

    • Liz Weston says

      One of my 401(k) rollover checks went to a complete stranger in Newport Beach, along with a bunch of other mail, when the US Postal Service bungled an address change request. Fortunately the guy was honest and tracked me down! It’s best to request that the money be wired (transferred electronically) to the new institution, but too often 401(k) administrators are stuck in the 19th century and insist on issuing checks.

  3. Hi Liz,
    I cringe when I see advice to roll over a 401k from an old job to the 401k from the current job with a reason like so you have just one account to manage. While this makes sense, it has a potential downside that should be mentioned with the advice. If you co-mingle the funds into one account, there may be disadvantages if you later have to divorce. If the funds from the old job include pre-marital assets (or might in a future scenario like a second marriage), it may be smarter to keep them separate so you can clearly identify account balances during a potential future division of assets and keep what is yours.

    During my divorce, I was able to keep the balance of the old 401k as of my marriage date as my own (not a joint asset) because the account was still there (hadn’t been commingled) and I had the statement for the account as of the date of the marriage.

    I am so happy I left my old 401k intact after leaving the old job. There were multiple times when I read that I should consider consolidating (with no mention of potential downside in the case of divorce). If I ever marry again, my old 401k contains only pre marital assets and I don’t have to worry about having to split it.

    Of course the laws where you live matter when it comes to division of assets (community property state or not).