What to Do With Your 401(k) After Changing or Leaving Your Job
Changing jobs or retiring is a very exciting time in anyone’s life. However, when leaving an employer, we leave behind more than just a boss and co-workers. For those of us that have spent at least a few years in a job, it's common to have a decent balance in our 401(k), 403(b), SEP account, or whatever retirement plan your employer had set up (to make things easy, I will just refer to everything as a 401(k) or retirement plan in this article).
After you actually leave a job, it is important to make a decision about what’s going to happen with the money in your 401(k).
As long as you meet certain minimums laid out by your existing retirement plan, most plans will allow participants to simply leave their money where it is after they separate from service. If your plan has good investment options, minimal or no additional fees, and/or you have plans to draw upon that money at age 55, then this may be an appropriate option.
However, in many cases rolling your assets into an IRA or a new employer’s plan can offer greater benefits compared to leaving the money where it is.
Rollover to an IRA
This ends up being the most common choice for those that are aware of their options. Rolling your old retirement plan into an IRA (Individual Retirement Account) can have numerous benefits from broader investment options to favorable withdrawal provisions to decreased costs.
Many employer-sponsored plans have additional fees beyond the expenses of the investments themselves. Some plans may have administrators or advisers that charge a fee to the plan. Sometimes this fee is paid by the company, but more often than not it takes the form of a percentage of each participant’s account. A more favorable option may be to open an IRA with an institution that does not charge a fee for holding the account.
Most employer-provided plans give participants a limited pool of investment options from which to choose. While some find this makes their investment decisions easier, you may not have access to quality, cost-efficient investments. The company or adviser determining what these investment options are may not necessarily have your best interests in mind, either. These funds could carry high fees and the range of options may not allow you to allocate and diversify your investments as well as you want to.
If you are under 59 ½, an IRA will also offer several withdrawal provisions that allow you to access your money without incurring the 10% penalty assessed on non-qualified distributions. Certain higher education expenses, first-time home purchases, and payment of health insurance premiums if you are unemployed all may qualify for penalty-free withdrawals from an IRA.
If you work with an advisor, moving your assets into an IRA will typically allow an advisor the ability to manage the account for you where they may be unable to if the assets remain in your previous employer’s plan. Having an advisor in your corner for investment advice, as well as other services such as financial planning or income management, can be extremely valuable.
However, there are some notable drawbacks to rolling your 401(k) over to an IRA. If your employer-plan happens to offer quality, low-cost mutual funds as investment options, these funds could be lower-fee “institutional shares” that you may be unable to invest in on your own. There are also several provisions that protect your 401(k) assets from creditors in the event of bankruptcy that an IRA is more limited in protecting.
Depending on your plans for retirement, your old 401(k) will allow you to access your money, penalty-free, a few years sooner. A terminated employee can access the funds in their plan as early as age 55 (instead of waiting until the year you turn 59 ½).
Rollover to Your New Employer’s Plan
Another, often beneficial, option could be to transfer your old 401(k) into your new employer’s plan.
Many individuals find it helpful to consolidate their accounts as much as possible. By moving your old account with a former employer that is no longer receiving contributions, you are able to simplify your investments a bit. Instead of trying to look at your full investment picture across multiple accounts, all of your assets residing in the new account can give a quick, convenient look for making decisions regarding asset allocation and risk exposure.
When you terminate employment and your status in that employer’s plan is made inactive, you lose the ability to draw loans from your assets in the plan (assuming loans were available at all through that plan). By moving those assets to your new employer’s plan you re-open the door to the availability of loans on your assets (again, this assumes the new employer allows plan loans). In most cases, it is preferable to take a loan on your 401(k) balance rather than receiving a distribution. This avoids taxes and penalty on receipt and basically forces you to repay yourself so that you aren’t depleting your retirement assets.
If you plan on working into your golden years, moving your assets into your current employer’s plan will allow you to defer required minimum distributions as long as you are still working. Beginning the year you turn age 70 ½, you must begin making distributions from your retirement accounts according to IRS regulations. The reason for this is so that government can finally take their cut of the pre-tax money you’ve been putting away for most of your working life. As long as you are still working for the company that holds your retirement plan, you are not required to begin making these distributions allowing for further tax-deferred growth.
Before making a switch, it will be important to review and compare several aspects of your old and new plans.
First, examine the fees and investments available in each plan. If the new plan you’re considering transferring assets to has onerous fees or unfavorable investment options compared to your old plan, then it may be prudent to leave the money where it is (or instead consider a rollover to an IRA).
As with the decision to roll money to an IRA, if you move the money into a plan with a current employer, you will lose the ability to access that those assets at age 55 under the separated from service provision of a 401(k).
This option should only ever be used as a last resort when you have an immediate, emergency need for cash.
If you are under age 55, you will generally pay ordinary income taxes as well as a 10% early withdrawal penalty. For example, if you are a 40 year-old who wanted to cash out your 401(k) that was valued at $100,000, you would owe taxes on this $100,000 as if it were income you earned just this year (so, your total taxable income for the year would be your regular wages plus this $100,000. This would likely send you into a higher tax bracket, further increasing your tax liability) as well as a $10,000 penalty for taking an early withdrawal. It is not uncommon in this scenario to sacrifice over half of your money to taxes and penalty.
Organize Your Options
Before you make any decision you will need to investigate your new workplace plan rules, compare underlying fees and investment options, evaluate any tax implications of a move, and decide if you want to seek out professional help for managing your investments. All of these factors can make one option more favorable than another.
As our society moves further away from entitlement programs and pensions and toward 401(k)s and plans that shift the investment burden onto the individual, it becomes essential to be on top of your retirement assets if you actually intend to retire someday.