There’s no shortage of things to do when changing employers. New colleagues, new job responsibilities, new benefits, a new commute … and the list goes on. One important item that’s easy to overlook is your employer-sponsored retirement plan. What, exactly, should you do with the assets you invested in your previous employer’s plan? The answer depends on several factors, including your account balance, other retirement savings, overall investment portfolio, plan options, new employer-sponsored plan and more. Here, we provide an overview of your potential options.
Option #1 – Keep your money in your previous employer’s plan.
If your previous employer allows you to maintain your 401k after you’ve left the company, you can certainly do so. But be careful. It can be difficult to maintain accounts across multiple institutions. If you’re not diligent, you could lose track of these assets down the road.
You should also keep in mind the following considerations before deciding to leave your assets in the plan.
- Minimum account balance – If you have less than $5,000 saved in the account, your employer may not allow you to maintain your plan after you’ve left the company. If you have less than $1,000, your employer may automatically issue a check for the balance. If a check is issued directly to you, the distributed amount will likely be subject to an automatic withholding of 20%, to help cover federal income taxes, as well as a 10% early withdrawal penalty if you haven’t yet reached age 59 ½.
- Fees – Before you make the decision to maintain assets in your former employer’s plan, be sure you fully understand the fee implications of doing so. Many employers cover certain 401k administration fees for their employees. However, once you leave the company, your account may be debited for fees such as bookkeeping costs, administration expenses and legal support for the plan. If these fees add up to more than your investment returns, you could actually lose money over time by keeping your account where it is.
- Outstanding loans – One benefit of leaving your assets in your former employer’s plan is that you may be eligible to continue paying toward any outstanding loans. On the other hand, if you roll over your account balance, any outstanding loan balance will be taxable as a distribution (and may also be subject to an early withdrawal penalty), and you will miss out on the additional retirement savings your loan repayments would have provided.
Option #2 – Complete a direct rollover to your new employer-sponsored plan.
Rolling over your 401k to your new employer’s plan can make it easier to keep track of all your retirement savings. Just be sure that your new plan has a wide range of investment options to meet your needs, as well as reasonable fees.
If you decide to move assets to your new 401k, you’ll want to complete a direct rollover rather than having a check made out in your name. This way, your assets transfer directly from your old plan to your new plan without causing any unintended tax implications or early withdrawal fees.
If you receive a check made out to you as a distribution from your previous employer’s 401k, a mandatory 20% will be withheld to help cover your income tax liability, and you’ll be responsible for paying taxes at your ordinary income rate come tax time. If you haven’t yet reached age 59 ½, you may also be responsible for paying a 10% early withdrawal penalty. You can avoid this by depositing the check in a new qualified retirement account within 60 days; however, it’s typically more efficient to complete a direct rollover and avoid the headache.
It’s important to note that if you hold publicly traded stock in your former company within your 401k and that stock has grown significantly in value, you’ll likely not be eligible for tax breaks associated with in-kind distributions if you roll over the stock to your new employer’s plan. This is a big consideration when deciding whether to move your account.
Option #3 – Complete a direct rollover to an IRA.
There are two primary benefits of completing a direct rollover to an IRA:
- You’ll likely have access to a wider range of investments. At Creative Planning, we believe diversification increases the likelihood of accomplishing a client’s goals and reduces portfolio risk when customized for a client’s circumstances. This chart offers a great illustration of the importance of access to a wider range of investments.
- You can maintain full control of your retirement savings without the various restrictions often imposed by employer-sponsored plans. This includes the ability to complete Roth conversions.
Depending on which investments you choose, you may also have the added benefit of saving on investment, management and administrative fees, which can all erode your investment returns over time.
Your wealth manager can help you decide whether it makes more sense to roll over to a traditional (pre-tax) IRA or a Roth (after-tax) IRA based on the current tax status of your assets, your goals for the future, your tax liabilities and more.
Option #4 – Cash out.
While cashing out your 401k is certainly an option, it’s often an unwise decision — especially if it’s your only source of retirement savings. Here are several reasons you should carefully consider the potential ramifications of cashing out before you lock in a decision to do so:
- Taxable income – Any cash that’s distributed directly to you from a qualified retirement plan is added to your annual income for tax purposes. That means you’ll be responsible for paying local, state and federal taxes based on your ordinary income tax rates. If your distribution is enough to push you up into the next tax bracket, you may end up paying even more than you anticipated.
- Early withdrawal penalty – As mentioned above, if you withdraw assets from your qualified retirement account before you reach age 59 ½, you’ll be required to pay a 10% early withdrawal penalty in addition to taxes.
- Missed investment opportunities – By taking your money out of the market, not only are you missing out on potential growth due to investment returns but you’re also missing out on the benefit of compounding interest within the account. Over time, the assets in your 401k can grow tax-deferred within the account, adding up to big savings over time. If you cash out your 401k, you’ll miss out on significant opportunities to grow your assets.
If you’ve recently changed employers and are unsure of your retirement planning options, Creative Planning is here for you. Our experienced advisors have significant experience navigating a wide range of distribution and rollover options. They work to ensure every aspect of your financial life is well cared for and helping you achieve your long-term goals. Schedule a call to learn more.
