Americans are fickle with their employers, and many will change jobs as often as they change cars. And considering that the 401(k) is the retirement plan of choice for most large companies, there’s a good chance you’ll need to decide what to do with your old 401(k) when you move on to greener pastures.
So what do you do with your 401(k) when you move to your next job? You basically have four options:
Take it and run…
You can accept it a cash payment, or more likely, a check made out to you. Though it is an option, it’s normally a horrible choice. Cashing out your 401(k) reduces your retirement savings, and that’s the whole reason we have the 401(k) in the first place. Unless you are looking at serious hardship without taking the cash, it’s best to keep it in a tax-advantaged retirement account.
First of all, your ex-employer is required by the IRS to withhold 20% for income taxes, immediately reducing your check by one-fifth. You’ll have to pay state and federal income tax on the amount withdrawn, so the amount withheld won’t even be enough to cover your final tax bill if you’re in a tax-bracket higher than 20%. Then, to top it all off, you’ll be assessed a 10% penalty for early withdrawal if you are younger than age 59 1/2.
One special consideration for those who are age 55 or older, you can cash out your current 401(k), without penalty, if you retire, quit, or are fired or laid off. But it only applies to the 401(k) with your last employer; you still cannot access the cash in your previous employer’s 401(k) plans without paying the 10% penalty until you are 59 1/2.
Leave it where it is…
You can leave it with your ex-employer if you have more than $5000 in your 401(k). If you have less than that, you’ll probably be required to do something else with it. Leaving it where it is may be a good idea if you like your ex-employer’s 401(k) investments better, or if it has lower fees than your new employer’s 401(k). Always be informed of any fees that will take a bite out of your assets, whether it’s in a 401(k), IRA, or brokerage account.
You won’t be able to add to a 401(k) if you leave it with your former employer. You also won’t have the option of taking out a loan on it. You may still manage your investments within your old 401(k), and will be able to periodically re-balance your portfolio when you need to.
Roll on over to your new employer…
You can roll it over to your new employer’s 401(k) plan. Maybe you like your new employer’s plan more than your old one. Your new 401(k) may have better investment choices, or the fees may be lower with your new employer. Or, all else being equal, a rollover to your new 401(k) can simplify keeping track of your retirement accounts; that would be one less account to manage. Also, if you’re close to age 55 and may consider an early retirement, rolling your old 401(k) into your new employer’s plan will allow you to withdraw those funds when you’re 55, without penalty, when you leave your job.
Be sure that you do a direct 401(k) transfer, or a trustee-to-trustee transfer. That way, the check will be made out to your new account, or wire-transferred directly to the new account. If they write the check out to your name, they will have to withhold that 20% for income taxes. And, you will have to make the full deposit within 60 days, meaning you’ll have to make up that 20% difference out-of-pocket. You’ll be able to get back that 20% when you file your taxes, but 20% of your 401(k) can be difficult to come up with in two-month’s time, especially if you have a significant amount in that account. Also, if you don’t make the deposit within 60 days, you’ll be hit with the 10% early withdrawal penalty, in addition to your federal and state income taxes.
Rollover, Good Boy…
You can move 401(k) funds into a rollover IRA. This may be the best option if you don’t particularly care for either your present or previous employer’s 401(k) plans, or if your next employer doesn’t offer the 401(k) plan.
Your investment choices won’t be limited to what your employers have chosen; IRAs have countless investment options. Also, you can shop around for low-fee investments. You will have numerous no-load mutual funds to choose from with an IRA. Many employers accept whatever investments are pitched to them for their company’s 401(k) plan; they may not shop around for the best deal like you would for your own money.
If you decide to rollover into an IRA, keep those 401(k) contributions in that rollover IRA separately from any other IRAs you may have. By keeping a separate rollover IRA, you will maintain the option of rolling those funds back into a 401(k) someday in the future. You may eventually move to a job with an employer who offers the perfect 401(k) for you. If you do, you’ll be able to move those funds from your rollover IRA back to a 401(k). On the other hand, if you combine 401(k) funds with regular IRA funds, you will no longer have the option to roll back into a 401(k).
The main concern with rolling into an IRA is that the law gives more protection and flexibility to the 401(k) than the IRA. You may borrow from your current employer’s 401(k) plan if your employer allows it; you cannot borrow from an IRA. Also, 401(k) funds have greater protection from creditors, lawsuits and bankruptcies than an IRA.
Sources:
irs.gov
brill.com/funds101
360financialliteracy.org
