Gone are the days of working at the same company for 30+ years. We live in a world of constant change, a trend in both personal and professional lives. The average individual works 4.4 years at a company before moving on to somewhere new. Now I realize this is not the case for everyone (I have been with my business for 10+ years and “N” has been with her company for 8), but a large number of employees will change companies over their career.
Whether you switch jobs often or only once, when the time comes you may need to ask yourself what to do with my 401(k) plan from my previous employer? Here is a list of available options.
Option 1 – Leave It
No one is going to make you take your money and run (unless you have under $5,000, in which case you may be forced to take your money and run). More often than not the existing investment company wants to keep your money so they can 1, earn money on your assets (charge you fees), and 2, keep the relationship open (they want your future business).
Leaving your money in your old employer plan means you are likely choosing a “do-it-yourself” model. If you are comfortable managing your investments and financial plan, this may be for you. If you don’t know what this means, don’t know how to pick your investments, or don’t know how this all fits into your financial plan, this may not be the best option.
With larger employers, you may be buying institutional share class mutual funds which may lead to lower expenses. The low expense is something you may be unable to replicate in a rollover IRA or smaller 401(k) plan. If you leave it, you may be limited to the investment options available within the 401(k) platform set by your employer (often 20 or less).
What many people do not know is that each plan has specific rules set by the company. You will be subject to these specific plan rules which may limit distributions (although loans may be available), and other activities in the account. These transactions might carry additional fees. And finally, you won’t be able to make any more contributions to the account.
It’s important to know that assets inside a 401(k) have unlimited protection from creditors under federal law.
Option 2 – Roll It
You can take your money and process a rollover, moving your money from the 401(k) into an IRA.
A rollover means you take your money from its current account and move it to a new account without incurring any tax or penalties. A rollover allows you to continue the tax deferred growth. You want to ensure you process a qualified rollover. If you get it wrong and you are under 59½, you may be subject to a 10% withholding and 100% taxation).
An IRA may often have more investment options than your existing 401(k), including most mutual funds, ETF’s, and individual stock positions. You can also roll multiple IRA’s into the same account, making life much easier by consolidating multiple accounts into one. It’s important to know that by rolling the money to an IRA you will be giving up some creditor protection that is offered in a 401(k).
Option 3 – Consolidate It
It may be possible to transfer your previous employer 401(k) plan into your new employer’s 401(k) plan. Consolidation is not an option for all 401(k) plans so you should check with your new HR department first before taking any actions.
In my opinion, consolidating your old 401(k) plan with your new 401(k) plan simplifies your life by keeping all your assets together. Once the transfer is complete, however, your account will be subject to the rules and regulations set by the new 401(k) plan. You will also be limited to the investment options offered by the new plan and have other similar issues as discussed in Option 1.
Fees and expenses may be lower if you were to choose to roll your money into your new employer’s plan rather than an IRA. Assets in a 401(k) also have unlimited protection from creditors under federal law.
Option 4 – Cash It
Your 401(k) is money earmarked for retirement, so cashing out is not a good idea. If you do take the money out as a distribution, you WILL be subject to income tax and potentially penalties (subject to your age and individual hardship distributions).
All distributions from your 401(k) plan will be subject to ordinary income on your federal tax return (taxation varies by state). If you are under 59 ½ years old, you will also be subject to an IRS penalty of 10% on the amount of your distribution.
If you unintentionally cash out your 401(k) plan, there is a provision that allows you to complete a qualified rollover within 60 days of the distribution without incurring taxes or penalties. If you find yourself in this predicament, it makes sense to speak with a financial or tax professional regarding your options.
So what to do now?
By thinking about the options I listed by reading this article, you have already placed yourself ahead of many job-changers. (Give yourself that pat on the back)
Second, know your current plan’s rules, expenses, and investment options and how they compare to the alternatives.
Consider if you have any special considerations. Are you a post 55, pre 59 ½ or retiree because there special rules that allow you to withdrawal penalty free? Do you have a large position in employer stock that has appreciated substantially? Are you a do-it-yourself-er or someone who is seeking professional assistance? Do you have any after-tax dollars in your account? These questions will help narrow down which option is right for you.
When you have made a decision and elected to move in one direction, or another, make sure you complete the paperwork correctly. A small human error of checking the wrong box or title could lead to an unintended premature distribution that could end up costing you lots of money in tax dollars. Not fun!