Take Your 401(k) With You

The statistics now say that the average person will have eight jobs by the time they're 30. That could possibly mean eight different 401(k)s as well. By the time you're ready to retire, you could have 401(k)s all over the place, and it could be a huge inconvenience trying to track all this money down. So you're better off keeping your 401(k)s organized as you move through your career.

When you leave a job, you have several options for what to do with your 401(k): cash out, leave the money in the plan, roll it over to your new company's 401(k) plan, or roll it over to an IRA.

Cash Out

This is tempting but generally a terrible choice. First of all, you'll have to pay taxes on the distribution, which defeats the purpose of putting the money into a 401(k) in the first place. Furthermore, if you're under the age of 59½, you'll have to pay a 10% penalty for an early distribution, leaving you worse off than if you had never participated in the 401(k). (Cashing out may be the only option the company allows you if you have less than $1,000 in the plan. But you shouldn't let this deter you from investing in a 401(k).)

Leave The Money In The Plan

You can simply do nothing and just leave the money in the plan. This is nice and convenient, but over time it will become very complicated when you rack up more and more 401(k) accounts. How many web addresses, logins, and PINs do you want to keep track of? The longer you wait to roll over the money, the harder it will be to track down former employers to get it all back. Since you generally won't receive quarterly statements as an inactive plan participant, you may even forget about an account or two! (However, if you made after-tax contributions to the plan, leaving the money there will simplify the task of remembering which contributions have already been taxed when you take the money out.)

Roll It Over To Your New 401(k) Plan

Rolling the money over to a 401(k) plan at your new company has the advantage of preserving the tax-deferred status while eliminating an unnecessary account. However, your new employer may have a waiting period during which you aren't eligible to participate in the 401(k) plan (I've seen waiting periods as long as a year). You also will be limited to the number of investment choices offered by the plan.

Roll It Over To An IRA

The best choice is usually to roll the money over to an IRA. You can set up an account called a rollover IRA at a financial institution such as Vanguard or Fidelity. The purpose of a rollover IRA is simply to accept rollovers from qualified plans such as 401(k)s; it has nothing to do with a Roth or traditional IRA, and it has no effect on the amount you can contribute to such accounts. A rollover IRA lets you keep all your 401(k) money in one place that stays with you, and gives you access to many different investment choices.

The one thing to be careful of with any rollover is that you always want to do a direct rollover, where the money moves directly from your 401(k) to your IRA without passing through you. This contrasts with an indirect rollover, where your 401(k) funds are given to you as a check, and then you deposit the money into the rollover IRA. Don't take possession of the money under any circumstances! If you do, 20% will be withheld for tax purposes, but you still need to deposit the full amount into the rollover IRA. This means that in addition to the 80% that you've received a check for, you also need to make up the remaining 20% with your own funds! Any portion of the money that isn't rolled over within 60 days is considered a distribution, meaning you pay taxes plus a 10% penalty if you're under 59½.

Despite the unpleasant situation of doing an indirect rollover and having to use your own money to cover the 20% that was borrowed by the government, a rollover is almost always the best choice. Just be sure to do a direct rollover, where you don't take possession of the money. This will let your 401(k) funds accumulate on a tax-deferred basis, and spare you the burden of having too many accounts to keep track of.