What to Do with A Small 401(k) When You Leave A Job

One of the many loose-ends you need to tie up when transitioning from one employer to another is figuring out what exactly to do with your retirement savings. When my boyfriend, whom I call Peach, left his first teaching job for an opportunity at a different school, he also left behind a modest 403(b). For those unfamiliar with the term, a 403(b) is similar to a 401(k) but used by non-profit organizations. He’d tucked away $1,500 in the nearly six months he’d worked in the school. While his employer said he could leave the money there, that isn’t always the case.

It’s expensive for employers to offer a retirement plan. An expense that sometimes gets subsidized by employees by paying administration fees as part of your plan, but it’s also a benefit an employer may not want to extend a former employee. I’ve worked for companies that required a $5,000 minimum balance in a 401(k) in order to leave funds in your current plan. The other options are to roll it over or take a withdrawal, but a withdrawal can trigger a tax penalty. Unfortunately, when your balance is small, you might feel there are really no options at first glance.

Brokerages like Vanguard and Fidelity often have minimums when opening a new account. Dumping your money into an S&P 500 index fund within an IRA would require $3,000 with Vanguard or $2,500 with Fidelity.

So if you’re like Peach and only have $1,500 – what can you do?

Option 1: Roll over into a new IRA with a target date fund.

When Peach first started this process I encouraged him to check out a roll over. He started playing around with the process of opening a new IRA on the Vanguard site and felt dismayed when a screen popped up to tell him he’d need another $1,500 to meet the $3,000 minimum in the index fund he wanted. He didn’t have another $1,500 in savings he felt comfortable locking up in a retirement account right then, so he felt stuck.

I told him to just call Vanguard directly. It’s amazing how many problems can be resolved by just calling – even though us millennials are allergic to the phone unless it’s being used for texting, tweeting or Instagraming.

Within a few minutes, a customer service rep explained that while most funds do have a $3,000 minimum, the target date fund only require $1,000.

A target date fund is one of the simplest ways to start saving for retirement. You pick the fund that’s most closely associated with your anticipated retirement year. For example, if you’re 25 today in 2017 and plan to retire by 65, then you’d want a target date fund closest to the year 2057. Some brokerages title funds in increments of five years though, so you’d do 2055 or 2060.

Target date funds will automatically rebalance your portfolio from aggressive to moderate to conservative the closer you get to retirement. It’s a passive way to be investing – and it does bother quite a few of the experts to have people be this lackadaisical about retirement planning. While it may be better to start with a target date fund just so you at least get your investing going, you should eventually take a more hands on approach in the future as you rebalance and asses your time horizon and personal risk tolerance.

Option 2: Leave money with the employer.  

In Peach’s case, he could’ve left his money with his employer. This strategy can make sense if you have low fees, good investment options and no roll over fee that gets triggered when you try to leave.

As of now, his employer isn’t requiring him to roll over or cash out his small 403(b) sum. But that doesn’t mean it would stay this way forever. It’s quite possible his employer or yours could change the rules in the future about account minimums and require you to move your balance.

Option 3: Don’t cash out [Yes, you technically can, but don’t].

 Yes, you can technically just cash out your small 401(k) balance. But just don’t do it. You’ll be shocked how quickly your money disappears after you have to pay taxes and a penalty for early distribution. You’ll have to pay taxes and then you’ll also owe a 10% early withdrawal penalty. Let’s say Peach had to pay 30% in federal, state and New York City taxes and then an additional 10% for the penalty. He’s retirement savings money would’ve dropped from $1,500 to $900. It’s just not worth losing such a significant chunk. Roll your money over or leave it with your employer. Just don’t cash it out!

 Pro Tip: Keep contributing to the new IRA

 You can keep contributing to your newly minted IRA once you complete your 401(k) roll over. If you had your eye on an index fund, then keep contributing to your target date fund until you hit that $3,000 minimum and you can change your allocation and put that money in your desired investment. While there may be a $3,000 minimum to open certain index funds, you don’t have to throw $3,000 in each time you want to invest. You can contribute up to $5,000 per year to your IRA.

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