Update: The deadline for making IRA contributions for tax year 2020 has been extended to May 17, 2021.
The nature of work is no longer what it used to be. Gone are the days of working for just one employer for an entire career. Now, it’s more common to move between lots of jobs.
A recent study by the Bureau of Labor Statistics reported that the average person will have nearly 12 jobs during the course of their career. The same study showed the median tenure for employees is just short of four and a half years for men and four years for women. That’s a lot of jobs.
And, that’s a lot of 401(k) accounts.
As the traditional model of work known to our grandparents is eschewed for the modern system of job-hopping, so have the pensions they enjoyed.
Instead, the average worker will likely have self-funded retirement accounts through each new employer—one common type of these retirement accounts is the 401(k).
This means that as employees move between jobs, many will be left with a hodgepodge of old, obsolete 401(k)s and other retirement accounts.
Is it best to leave them as they are, or to consolidate 401(k) accounts? And if so, how?
Here are some pros and cons of the most popular options for 401(k) consolidation to help you answer the question, “Should I combine my 401(k) accounts?”
What You Need to Know About 401(k) Plans
A 401(k) is a workplace-sponsored retirement plan. This means that your workplace chooses the institution where the 401(k) is housed and will send money from your paycheck to the plan on your behalf. (Though you typically still choose whether to send and how much is sent.) Often 401(k) accounts are offered to employees as a workplace benefit, like vacation days and healthcare coverage.
Many companies offer a 401(k) match. This is where a company contributes money to an employee’s 401(k) to match the amount of money that the employee has contributed. A company match program can make a 401(k) a very lucrative place to save money for retirement.
That said, not all companies offer a 401(k) match. Still, 401(k) plans are considered an advantageous way to save retirement money because they have certain tax advantages over “regular” savings accounts, such as the ones offered by a commercial or online lender.
And 401(k) accounts are referred to as “tax-deferred” because income taxes are deferred until later, when you pull the money out in retirement.
Additionally, all investments within 401(k) accounts grow tax-free.
The taxation of retirement accounts is an important consideration in long-term financial planning. Taxation also acts as our guide for knowing what retirement account types can be combined, and which types cannot be combined with other retirement account types.
Because all 401(k) accounts share the same tax status (tax-deferred), they can be combined. Traditional IRAs are also tax-deferred and can be combined with a 401(k) account.
A Roth IRA is another popular retirement account type. A Roth IRA cannot be combined with a 401(k) or a traditional IRA accounts because it has a different tax status.
Should I Combine My 401(k) Accounts?
If you’re reading this article, you might be at the point during your career where you’ve got at least one 401(k) account that you’re no longer contributing to. If you are wondering whether to combine your 401(k) accounts, here are a few of your options:
1. Rolling the 401(k) account(s) into your active 401(k).
2. Rolling the 401(k) account(s) into a Traditional IRA at an institution of your choosing.
3. Doing nothing, and leaving the account(s) as-is.
Everyone’s financial situation is different, so consider the pros and cons of each option when trying to decide what is best for you. When weighing your options, here are some things you might consider:
Option 1: Rolling Over into Your Active 401(k)
Your first option with the 401(k) you no longer contribute to is to roll the money into your active 401(k) account with your current employer. This is a good option to consider if you want to have all your tax-deferred dollars in one place.
1. A single place for all tax-deferred money
By rolling all old 401(k) accounts into an existing 401(k), you are consolidating those tax-deferred accounts into one place. You may find managing just one account an ideal scenario.
2. Consolidating your investment strategy
The act of consolidation isn’t just ideal for cosmetic reasons. It may make it easier to keep track of your money and manage a cohesive investment strategy. It can be challenging to manage a bunch of different retirement accounts.
1. Limited investing options
Sometimes, 401(k) plans have limited investing options. If you like the options that you have available, this may not be a hangup for you. By looking at the investment option information provided by your plan, you should be able to make an informed decision about how you want to direct your investment.
Before moving more money into an active 401(k) plan, you may want to investigate both the fees charged by the account and the investing options.
2. Additional fees
Sometimes, 401(k) accounts have additional fees on both the accounts and investments themselves.. Check to see if fees are assessed at a flat rate, or if they are assessed as a percentage of the amount invested. This may influence your decision to roll over other 401(k)s into your active 401(k).
How to do it:
It starts with contacting the institution that holds your old 401(k) and requesting a rollover to your active 401(k). The customer service representative should likely be able to help you on the phone or direct you to the paperwork online. It can be smart to clarify that this is a rollover to another tax-deferred account.
Ideally, the company is able to transfer the funds electronically to your active 401(k). If they are not able to do this, they may request an address to send a check. It can be a good idea to procure the address of the financial institution where your 401(k) is located before making the call.
Option 2: Rolling into an IRA
Rolling all old 401(k) accounts into a Traditional IRA of your choosing is a popular choice that allows you maximum control over the investments within the account.
1. You choose the institution
You get to choose where to open your individual retirement account. By choosing an institution, you can choose somewhere that tailors specifically to your needs. You will have control over your investment choices and whether to use an institution that charges for certain services.
This may be especially important if the institution that holds your current 401(k) charges account maintenance fees or only offers high-cost investment products.
2. You’ll always control it
You open a Traditional IRA on your own and without an employer—therefore, a Traditional IRA is always and only yours. Some people may find it helpful to think of a Traditional IRA as a “home base” for their tax-deferred money. As you move through your career, you can roll old 401(k) accounts into a Traditional IRA that’s not going anywhere—it’s your home base.
3. More investment options
As compared to some 401(K) programs, a Traditional IRA opened at an institution of your choosing may have more options for investing.
Some 401(k) programs may require that participants choose from a pre-selected list of options. Sometimes, options may be high-cost mutual funds. If you open a Traditional IRA at a brokerage firm or other financial institution, you’ll have the benefit of the broker’s wisdom and experience. Asking the right questions is key to making sure that person is the right fit for you.
1. You may still have multiple accounts to maintain
Even if you open a Traditional IRA, you may still want to contribute to your active 401(k). Therefore, you will need to maintain at least two retirement accounts. (And perhaps three, if you have a Roth IRA, which cannot be combined because it has a different tax status.)
(Still, having two accounts—an active 401(k) and a Traditional IRA—might be better for you than having many multiple 401(k) accounts scattered around at different financial institutions.)
2. It may complicate a “backdoor” Roth IRA
A backdoor Roth IRA is a way to contribute to a Roth IRA when your income is too high to contribute to one directly.
Though you’ll want to check with a tax professional, it is generally understood that a backdoor Roth IRA might be complicated if your Traditional IRAs contain a mix of pre and post-tax money that you put in.
If you want to pursue a backdoor Roth IRA, you may want to roll your old 401(k) assets into your current 401(k), or leave the account as it is. The greater the balance in your Traditional IRA, the greater the tax liability for the backdoor Roth IRA contributions since you can only contribute money that’s already been taxed to a Roth IRA.
How to do it:
If you do not already have one, you may want to open an IRA account at a financial institution of your choosing. This could be at a bank or other financial institution. Rollover IRAs are available through both SoFi Active Invest and SoFi Automated Invest.
Once your Rollover IRA is open, you can roll funds from your 401(k) into the Rollover IRA. The process is generally similar to that of rolling assets into an active 401(k) (see above).
Option 3: Doing Nothing
Lastly, you may opt to leave your 401(k) accounts exactly as they are. Here are some pros and cons of this strategy:
1. You are happy with the financial institution and/or investments
If you like your current investment allocation and investment options and want to continue using them, you may choose to leave your 401(k) as it is.
1. Difficult to manage
It could be hard to manage a cohesive investing strategy across multiple accounts. This may be especially true for someone that has multiple accounts at different institutions.
2. Cannot add money to an old employer-sponsored 401(k)
It is not possible to contribute new money to an old 401(k) account that was previously tied to an employer. New money must go into a current 401(k) or some other self-directed retirement account, such as a Solo 401(k), Roth IRA, or Traditional IRA.
If you do not currently have access to an employer-sponsored 401(k), you may want to seek out another retirement account for which you can make contributions.
3. Possible maintenance fees
Old 401(k) accounts may charge monthly or annual fees such as account maintenance fees. By consolidating, it may be possible to eliminate all or most of these fees.
For example, a person could roll old 401(k) accounts that charge a maintenance fee into an account that has no such fee, whether that be their current 401(k) or a Traditional IRA.
4. Limited investing options
Because a person does not get to choose the bank that holds their employer-sponsored 401(k), they don’t get to determine the plan’s investing options, either. Therefore, it’s up to you to decide whether the available investment options in your old 401(k) are sufficient.
People may benefit from consolidating their 401(k) accounts into their current 401(k) or into a Traditional IRA, if for no other reason than to consolidate their money under one roof.
It can be hard to manage a bunch of different accounts at different institutions, and may only get harder as we progress through our careers and end up with even more 401(k) accounts.
In general, a Traditional IRA can provide more flexibility and investing options than a 401(k). It means that you’ll be managing two accounts, yes, but it might be worth it to keep a Traditional IRA as a home base to roll all old 401(k) accounts into over time.
When you open an IRA, you’ll want to find a bank or financial institution that meets your needs. Many investors prefer to institutions where they will not be charged with unnecessary fees and have access to a myriad of low-cost investing options such as index funds.
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