In today’s article, we’re covering one of the most common questions we get here in our office: what do you do with a former employer 401k. For a lot of families, this is really the first time they take a look at their retirement accounts while they’re still working.
Research shows that the average American employee switches jobs 12.3 times before retiring.
Changing jobs can mean that many Americans have old 401(k) plans, which may not be properly positioned to help them prepare for retirement.
Every time you change jobs, you have some choices to make about your old 401(k).
Generally, there are four basic options for a former employer 401k:
- You can leave the assets in your former employer’s plan, if permitted.
- You can roll over the assets into your new employer’s plan, if the plan accepts transfers.
- You can roll the assets over into an Individual Retirement Account (IRA).
- You can take the cash value of your account (and manage the potential tax consequences).
Each of these choices has advantages and disadvantages to consider.
In today’s article, we’ll show you how to avoid common (and expensive) mistakes and how your 401(k) can play a key role in your retirement preparations.
Remember, you have at least 30 days to decide what to do with your 401(k) when you switch jobs.
If you’re thinking of making changes or need help navigating your own personal situation, please be sure to contact our office before making any changes. We can help you look at all angles of your circumstances and create a strategy that’s aligned with your financial goals.
Individuals have four choices with the 401(k) account from their previous employer.
Choice 1: Leave It with Your Former Employer
You may choose to do nothing and leave your account in your previous employer’s 401(k) plan.
However, if your account balance is under a certain amount, be aware that your ex-employer may elect to distribute the funds to you.
There may be reasons to keep your former employer 401k —such as investments that are low cost or have limited availability outside of the plan.
Other reasons are to maintain certain creditor protections that are unique to qualified retirement plans, or to retain the ability to borrow from it, if the plan allows for such loans to ex-employees.
A 401(k) loan not paid is deemed a distribution, subject to income taxes and a 10% tax penalty if the account owner is under 59½. If the account owner switches jobs or gets laid off, any outstanding 401(k) loan balance becomes due by the time the person files his or her federal tax return.
The primary downside is that individuals can become disconnected from the old account. This can lead to paying less attention to the ongoing management of its investments.
Choice 2: Transfer to Your New Employer’s 401(k) Plan
Provided your current employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you may want to consider moving these assets to your new plan.
One of the best arguments in favor of rolling over your old retirement plan is that it can help simplify your life.
In our experience, investors tend to lose track of accounts that aren’t right in front of them.
Life gets busy, and failing to modify your investment strategies to keep up with your needs can undermine your long-term financial success. Putting your assets in one place can help ensure that your investments remain consistent with your financial goals.
If you are considering this choice, remember to take a look at your new employer’s plan before making the switch.
- First, make sure the new plan has the investment choices that you are looking for.
- Second, check out the fees associated with the new plan.
- And third, see when you can join the plan. In some instances, you have to wait until the next enrollment period.
The primary benefits to transferring are the convenience of consolidating your assets, retaining their strong creditor protections, and keeping them accessible via the plan’s loan feature.
If the new plan has a competitive investment menu, many individuals prefer to transfer their account and make a full break with their former employer.
Choice 3: Roll Over Assets to a Traditional Individual Retirement Account (IRA)
Another choice is to roll assets over into a new or existing traditional IRA. It’s possible that a traditional IRA may provide some investment choices that may not exist in your new 401(k) plan.
In most circumstances, once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA). Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. You may continue to contribute to a Traditional IRA past age 70½ as long as you meet the earned-income requirement.
To initiate the rollover, you’ll need to select an IRA provider and work with your former employer 401k plan administrator. If the money is moved directly from your plan administrator to the IRA provider, no taxes are due on the assets that you move and any new earnings accumulate tax deferred.
In recent years, Roth 401(k) plans have been provided by more 401(k) plan administrators. Rolling over your Roth 401(k) is a similar process to rolling over a traditional 401(k). If the money is moved directly, no taxes are due on the assets that you move and any new earnings accumulate tax deferred.
The drawback to this approach may be less creditor protection and the loss of access to these funds via a 401(k) loan feature.
Remember, don’t feel rushed into making a decision. You have time to consider your choices and may want to seek professional guidance to answer any questions you may have.
Related: Roth IRA Versus Traditional IRA
Choice 4: Cash out the account
The last choice is to simply cash out of the account. However, if you choose to cash out, you may be required to pay ordinary income tax on the balance plus a 10% early withdrawal penalty if you are under age 59½.
In addition, employers may hold onto 20% of your account balance to prepay the taxes you’ll owe.
Think carefully before deciding to cash out a retirement plan.
Aside from the costs of the early withdrawal penalty, there’s an additional opportunity cost in taking money out of an account that could potentially grow on a tax-deferred basis.
For example, taking $10,000 out of a 401(k) instead of rolling over into an account earning an average of 8% in tax-deferred earnings could leave you $100,000 short after 30 years. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
The Next Steps
There are so many personal factors when it comes to preparing for your retirement. My goal is to help navigate and provide all the education I can to help you make the right decision for your personal circumstances.
I know there’s a ton of information to take in, and I would love to help you sort it all out. What questions do you have for us here at WAG?
We’re happy to work with you either in person, over the phone, or virtually, based on your preference. Give our office a call and we can schedule some time together.
