Taking your 401(k) with you may make sense
Here are a few factors to consider before deciding whether to keep your money where it is or take it with you.
- Consolidating your money makes it easier to track & manage
If you go through a series of career changes, you may find yourself with multiple 401(k) plans. Keeping track of all those accounts and managing your asset allocations across several different portfolios may be more trouble than it’s worth.
- Extra retirement accounts may mean extra fees
Fees may include sales loads, commissions, fund expenses, advisory fees, plan administration and customer service. In some cases, employers pay some or all of those expenses for their employees—but not always for ex-employees.
- Take advantage of additional investment choices or services
Most 401(k) plans offer a limited array of mutual funds or similar investment options. You may find that you have more choices—and possibly better service options—in a different type of retirement account. If you move your 401(k) to an IRA, you may have a much broader range of funds to invest in and, in many cases, access to a larger universe of stocks, bonds and other investments.
- Get more of your money sooner
If you’re leaving your job and will also be 55 or older in the same calendar year you’ll be able to take money out of your 401(k) plan without the 10% penalty for premature distributions. That’s the good news. However, when you take it, the plan administrator is required to withhold 20% of the distribution as a prepayment of taxes. Whatever isn’t needed to cover the taxes due, will be accounted for but not until you file your tax return.
If, on the other hand, you take money from an IRA the mandatory 20% withholding will not apply. In addition, if you are at least age 59 ½ you’ll also avoid the 10% penalty for premature distributions (other penalty exceptions may apply).
- Leave it in your former employer’s plan
If you’re allowed to leave your money in your former employer’s plan, you may find it easier to do so. You might also find that you like the investment options in your old plan better than the choices in your new employer’s plan, there is no administrative work, or the fees and expenses may be lower. There may also be more protection from creditors and legal judgements. Although keeping it there may not be an option, particularly if it has $1,000 or less.
Options for moving your 401(k)
If you choose to move your money out of your former retirement plan, you have three primary ways to do so, with each offering several advantages and disadvantages.
These options are:
- Cash it out and pay the taxes and any penalties.
- Roll over the money to your new company’s 401(k) plan or other employer-sponsored retirement plan, such as a 403(b) plan or SEP IRA (if offered).
- Roll over to a traditional or Roth IRA.
Let’s look at each in more detail.
Cash it out
If you cash out your 401(k), you would typically be required to pay taxes on the withdrawal at your ordinary income tax rate. If you’re under age 59½, you would normally be assessed a 10% penalty fee for early withdrawal unless an exception applies. In addition, your soon-to-be-former employer is required to withhold 20% of your distribution toward the federal income tax you may owe.
The early withdrawal penalty may not apply for those who terminated service with their employer at age 55 or over. (See: IRS 401(k) early withdrawal rules)
Roll it over to your new company’s plan
If you decide to roll over your money to your new company’s 401(k) plan, your former employer’s plan administrator would take care of transferring the assets. You then would likely need to decide how to reallocate your money into the investment options offered in the new employer’s plan. If you plan to work into your 70’s or later, your new company’s plan may have additional advantages when it comes to taking your required minimum distributions (RMDs).
Roll it over to a traditional or Roth IRA
One of the main advantages of rolling a 401(k) plan into a traditional IRA is being able to avoid the tax consequences. (See: Making sense of rollovers and transfers)
If you don’t already have an IRA, you may be able to open one online. Once your account is set up, your plan administrator can easily roll your 401(k) into it—although you’ll still need to be involved to provide all the necessary information. (See: Rollovers: Moving your 401(k) and retirement assets)
If you roll over your 401(k) money to a Roth IRA—which is different than a traditional IRA— you would have to pay federal taxes on any pre-tax dollars that are rolled over at your ordinary income tax rate. But the 10% penalty for early withdrawal would not apply. Once the money is in your Roth IRA, your investments would grow tax-deferred.
A note on employer stock. Under the net unrealized appreciation rules, employees may be able to roll over their employer stock to a brokerage account and pay tax at more favorable long-term capital gains tax rates when the shares are sold. If employer stock is transferred in-kind to an IRA, any appreciation would be taxed at the higher ordinary income tax rates upon distribution rather than the lower capital gains rates. When deciding what to do with your employer stock, also consider the risk of maintaining too heavy of a concentration in a single security within your retirement accounts.
This is an overview of some of the complexities involved when deciding how to handle your 401(k) at a former employer. The information provided is not intended as a source for tax, legal or accounting advice. Please consult with a legal and/or tax professional for specific information regarding your individual situation.