I recently started a new job and have a 401k from my previous employer that I don't know what to do with. Should I roll it into my new employer's 401k, a traditional IRA or a Roth IRA?
You can't roll it over to a Roth IRA without tax penalties.
The best thing to do is roll it to an IRA that isn't tied to work at all. Second best is to roll it into your new employer's 401k. The reason that an IRA makes sense is that it gives you the same tax savings as a 401k, but it allows you to remain in control of the money regardless of your employment status.
I agree with harmanjd – best to roll it over to an IRA. Not only does that afford you better control of your money as pointed out already, but:
If you choose your IRA provider wisely, you can get an account that provides you with a much wider array of investing choices, including funds and ETFs that charge much lower fees than what you would have had access to in an employer 401(k) plan.
But here's one thing to consider first: Do you hold any of your previous employer's stock in your old 401(k)? There are special rules you might want to be aware of. See this article at Marketwatch: If your 401(k) includes your company's stock, a rollover may be a bad move.
You should never roll a 401(k) to a Roth IRA. If the intention is to do so, you are better off rolling to a traditional IRA, and then converting. (Per the comment below, I should add - if the 401(k) contained post tax money, this portion rolls to a Roth, not a Tradition IRA. You then have the exercise of converting/recharacterizing just the TIRA money, as the Roth stands aside) This preserves the ability to recharacterize back to a traditional IRA. You might wish to do this if:
- The market crashes, or specifically, your investments crash. Why pay tax to convert say $20K of funds to a Roth when the funds are now worth $12K? Convert again in the next year, and cut the bill 40%.
- The conversion puts you in the next bracket. The best conversion strategies I've seen use a small conversion each year to top off the 15% bracket, whereas a wholesale conversion would push the taxpayer into the 25% rate.
- You change your mind and don't want the tax bill that year.
The answers so far are great, but I'll add what I see missing -
- The 401(k) may offer a loan option. The debate whether this is a good option is certainly valid. I like options, whether I use them or not.
- The 401(k) permits penalty free withdrawals for those 55 and older when separated from service. An important option for those who retire early or are let go at age 55 or older.
- For those who wish to have Roth deposits but are above the income limit, there's the ability to deposit to a traditional IRA, and convert. If there's an existing IRA, the pretax money is pro-rated and taxed on conversion.
- A 401(k) of a large company may have very low cost funds. Our S&P fund expense is .02%, compared to ETFs at .05%. If your 401(k) expense is much above .05%, that's a factor against rolling to it. Much above .75%, and I might not deposit to it at all let alone add an old 401(k) to it.
Rolling a 401(k) to an IRA should be your default best option.
Rolling a 401(k) to another 401(k) is rarely the best option, but that does happen. I've done it once when I started a job at a company that had a great 401(k) with a good selection of low-cost mutual funds. I rolled the 401(k) from one previous job in to this 401(k) to take advantage of it. In all other cases, I rolled 401(k)s from previous jobs to my Rollover IRA, which gave me the most freedom of investment options.
Finally, with 401(k)-to-Roth IRA rollovers, it's important to decouple two concepts so you can analyze it as a sum of two transactions:
- the rollover part, which means changing the financial provider; the logic of choosing your provider is essentially the same, whether your money ends up in a "traditional" or Roth IRA
- the traditional-to-Roth conversion, which is a taxable event; the tax consequences are essentially the same whether you change providers at the same time or not.