By: Gene Walden, Senior Finance Editor August 27, 2019
If you recently accepted a job with a new company, you may be leaving something important behind – your 401(k) retirement plan.
Even if you’re in no rush to close out your 401(k) account at your former employer, keeping it there may not be an option, particularly if it has $1,000 or less.
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.
If you decide to transfer out of your former company’s plan, you have three primary options:
1. Cash it out and pay the taxes and potential penalties.
2. Roll over the money to your new company’s 401(k) plan or other employer-sponsored retirement plan such as a 403(b) or SEP-IRA (if offered).
3. Roll it over to a traditional IRA or a Roth IRA (taxes will apply when rolling to a Roth IRA).
There are some compelling reasons for moving your money out your old plan. Here are some factors to consider before you decide:
• Consolidation makes it easier to track and manage your money
If you go through a series of career changes, over time you may find yourself enrolled in multiple 401(k) plans. It may become cumbersome keeping track of all the accounts and managing your asset allocation across several different portfolios.
• You could pay more in fees with extra retirement accounts
Those fees may include sales loads, commissions, fund expenses, advisory fees, plan administration, and customer service.
In some cases, the employer pays some or all of those expenses for their employees – but not always for ex-employees. The more 401(k) plans you have from previous jobs, the more fees you may be paying. You may be able to minimize those fees by consolidating your accounts. (See: FINRA Rollovers to Individual Retirement Accounts)
• You may find more investment choices or services elsewhere
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 qualified plan. Many IRA plans allow you to invest in a much broader range of funds and, in many cases, a wide universe of stocks, bonds, and other investments.
• You may want earlier access to or more protection of your assets.
While employees who leave their job in the year they reach age 55 or later can take penalty-free withdrawals from their 401(k) plan, there is a mandatory 20% tax withholding on those distributions. Withdrawels can be made from an IRA without penalty at age 59½ or later (other penalty exceptions may also apply), there is no mandatory tax withholding. Also, employer-plan assets normally have unlimited protection from creditors under federal law. IRA assets are protected in bankruptcy proceedings only - state laws vary regarding the protection of IRA assets in lawsuits.
Where to move your money
If you choose to move your money out of your former retirement plan, you have three primary options that each offer several advantages and disadvantages. The Financial Industry Regulatory Authority (FINRA) suggests that you take a variety of factors into consideration before making your decision, including your “desired investment options and services, fees and expenses, withdrawal options, required minimum distributions, tax treatment, and the investor’s unique financial needs and retirement plans. The complexity of these choices may lead an investor to seek assistance from a financial adviser, including a broker-dealer."
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 are under age 59½, you would normally be assessed a 10% penalty fee for early withdrawal unless an exception applies. Your soon-to-be-former employer is required to withhold 20% of your distribution towards 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. There are also some other penalty exceptions, including hardships. For more see: IRS 401(k) Early Withdrawal Rules.
Something else to note: If the 401(k) has between $1,000 and $5,000, and you don’t elect to receive the money or roll it over, the plan administrator may deposit it in an IRA in your name. (See: IRS Rollovers).
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 execute the transfer of assets. You then would likely be required to reallocate your money into the investment options offered in the new employer’s plan.
Roll it over to a traditional IRA
Rollovers from 401(k) plans to IRAs account for most IRA assets in the U.S. According to FINRA, more than 90% of the assets flowing into IRA accounts have traditionally come from rollovers, primarily from employer plans.i
If you don’t have an IRA account, you may be able to open one online. Once your account is set up, rolling over your 401(k) is a routine matter that should be handled by your plan administrator, although it may also take some effort on your part to provide all the necessary information. (See Rollovers: Moving your 401k and retirement assets for more information.)
If you choose to open an IRA with Thrivent Mutual Funds, make sure to select “Retirement Plan Rollovers” when choosing your account type. That way we’ll lead you through all the steps necessary to set up an IRA as well as provide help to make the request to your former employer to rollover the 401(k) assets.
If you are rolling over your 401(k) to an IRA account, you can allocate your money to various funds or other available investment options . As part of the Thrivent Mutual Funds step-by-step online account establishment process, investors select the mutual funds in which they want to invest.
An investor who holds employer stock in a former employer’s plan that has had significant appreciations should consider the negative tax consequences of rolling the stock to an IRA. If employer stock is transferred in-kind to an IRA, any appreciation would be taxed as ordinary income upon distribution.
FINRA suggests that “the tax advantages of retaining employer stock in a non-qualified account should be balanced with the possibility that the investor may be excessively concentrated in employer stock. By holding the stock in a non-qualified account any appreciation in the employer stock in excess of the basis can be taxed at the more favorable long-term capital gains rates (ordinary income tax applies to basis, and potentially the 10% penalty). It can be risky to have too much employer stock in one’s retirement account; for some investors, it may be advisable to liquidate the holdings and roll over the value to an IRA, even if it means losing long-term capital gains treatment on the stock’s appreciation.”
Roll it over to a Roth IRA
If you roll over your 401(k) money to a Roth IRA, you would typically have to pay federal taxes on the rollover amount at your ordinary income tax rate, but you would not be stung with the 10% penalty for early withdrawal. Once the money is in your Roth IRA, your investments would typically grow tax-deferred within the account.
Distribution of your contributions from a Roth IRA can be tax-free; however, with certain exceptions, earnings could not be withdrawn tax-free until you reach the age of 59 ½ – and after you’ve had the account for at least five years. If you take a distribution of earnings before that, it could be taxable and the 10% penalty for early withdrawal could apply as well. Specific requirements apply to amounts rolled over into a Roth. (See: Making sense of rollovers and transfers for more information.)
There is one other unique benefit of a Roth IRA. With a 401(k) or traditional IRA plan, you are required to take minimum distributions after age 70½ but a Roth IRA has no such requirement. The money can stay in your Roth IRA account for as long as you live, potentially accumulating tax-free gains for years to come (although your beneficiaries would be subject to required minimum distributions). (See: The power of pairing your 401(k) with a Roth IRA)
Before you make your final decision on how to handle your 401(k), Thrivent Mutual Funds recommends that you consult your tax advisor to make sure you’re getting the most out of your investments. Thrivent Mutual Funds and their representatives cannot provide legal or tax advice. (See more on The pros and cons of rolling over your 401(k) investments.)
i FINRA Rollovers to Individual Retirement Accounts. December 2013.
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