Changing jobs? 401k must-knows

• Changing jobs? 401k must-knows
  • The opportunity
    • A non-Greg example
  • What your options are for your old account
    • Which one?

I recently changed jobs and was going through the hassle of figuring out how to maximize my traditional 401k space. I have a spreadsheet with the sum total of contributions to Employer A at the time of my resignation and keep a tally of Employer B contributions + remaining paychecks (to make sure I don't go over!).

Then something dawned on me...the IRS is silly, and with silliness comes potential for opportunity! As to not bury the lede on this specific juicy detail, I'll cover it first, then cover the basics!

The opportunity

$140,000 of tax advantaged space <-- The lede!

This is the major kicker, the "if you know you're going to leave a company and have ample savings capabilities" opportunity. Here's the math**:

• Employee deferral: $23,500
  • This is a limit applied across all accounts, much like IRA contribution limits
  • This is comprised of both Roth (direct, more on this later) & Traditional employee contributions
• Employer contributions: Whatever your companies offer!
• Total, per account, limit: $70,000

** All numbers above are from IRS documentation
*** Also note: if over 50, catch up contributions apply, too!

Now, you may be looking at this and not seeing how a maximum of $23,500 employee deferral across both accounts + employer contributions = $140,000 (unless you have two, very, very generous employers!).

This is where after-tax contributions comes into play! If you recall from 401k contribution limits, some 401k plans give employees the opportunity to fill the remaining difference between the $70,000 total 401k cap, and your deferral contributions. While this does not have many direct tax benefits (and frankly has negative tax benefits on its own, relative to brokerage accounts), if converted to Roth, it creates what's known as the megabackdoor Roth conversion. Essentially, any after-tax dollars becomes Roth.

Starting to click? If you have two 401ks that both offer MBDR, you have access to two individual account limits of $70,000 a piece. This is not-so-explicitly called out in the example of "Greg" in the IRS documentation on "overall limit on contributions". Greg has 2 401ks, simultaneously, as a self-employed & also company employed person. Greg is allowed to contribute his deferral amount to his 401k plan, but also max out his plan limit for his solo 401k.

As a refresher, your contributions must be less than $23,500 for the deferral, your employer contributions count towards each specific $70,000 cap, and you can fill the after-tax amount for each account.

A non-Greg example

Let's say I work for Employer A who has a match (made up numbers here). I know I'm going to change jobs, I'm miserable, the market's hot, my comp is low. Knowing this (and how long interviews take!), I set out to max my 401k asap.

By April (Jan-Mar), I contribute $23,500 of traditional (pre-tax) contributions. This comes with a match on my salary for let's say, $3,000. I know my contributions will amount to $23,500 towards the $70,000 limit, so I add the difference in after tax ($46,500).

Since I maxed my deferral at Employer A and Employer B only matches on employee deferrals, I have $70,000 of 401k space to use via after-tax contributions.

At the end of the year, this amounts to a sum total of: $23,500 of traditional ($23,500 deferral + $3,000 of pre-tax income by way of employer match) and $113,500 in Roth (by way of after-tax -> Roth conversions via the MBDR method).

There are some blatant caveats here, such as HR allowing you to go over some pre-defined after tax limit, having the ability to even afford to make this level of contribution, etc. However, in theory, this is all possible!

What your options are for your old account

1. You may leave the balance in your current retirement plan
2. You may roll the balance over to another eligible retirement plan
3. You may cash out the balance (subject to taxes and potential penalties)
4. You may roll the balance over into a tax-deferred Individual Retirement Account (IRA)

Which one?

One of these is not like the other, one of these is a bad idea and it'll cost you. Cashing out your 401k should be a no brainer; it's expensive and I struggle to think of a time where this is the best option. Here's my best defense of it: You have a low balance, you're over 59.5 and withdrawing from a traditional account aligns with your drawdown strategy and you would have to pull from traditional anyway. Otherwise you're looking at 10% early withdrawal penalties and income taxes on the entire balance of traditional, and 10% early withdrawals on the Roth gains!

That leaves us with "roll over", "leave it" and "IRA".

An IRA is often touted as a great option because of the amount of control you have over the funds. I don't disagree! However, there's a few implications that are rarely brought up.

1. You are not going to have the same economies of scale in your personal IRA as your company 401k plan. What that means is your investment options can be impacted. For instance, VTSAX has a minimum buy in of $3,000. It has an expense ratio of 0.04%. The equivalent index is used for VITSX that offers a 0.03% ER...with a minimum investment of $5,000,000. If you had access to VITSX in your 401k but don't have $5,000,000 in your IRA, you're going to pay more for the same investment.
2. If your 401k has a traditional balance and you're a high income earner, you'll want to read up on the implications. It may eliminate your ability to do the backdoor Roth IRA.

Leave it vs Roll over are essentially two sides of the same coin: which 401k is better?

The main factor in leave it vs roll over is how good the plan is. A plan can be evaluated on its investment options, the fees of those investments, and any account fees. Most of it is pretty cut and dry, but here's how to evaluate the investment fees: Let's say you have $500,000 in FSKAX (Fidelity total market fund). Your new employer offers VTSAX (Vanguard total market fund). If you were to roll it in to your new 401k, you'd be increasing your expense ratio from 0.015% to 0.03%. If we had 7% returns over a 20 year period, that difference amounts to approximately $5,000 of added expenses for tracking the same index.

If all these factors are approximately the same (thanks to the industry moving to low fee indexes as a common option, it is likely), then the question becomes: "do I deal with the hassle of a roll over" or "deal with the hassle of maintaining two accounts". One is temporary pain (hassle of a rollover), the other is longer term, though smaller. It's largely personal preference.