Changed jobs? Options for your 401(k)
One of the common threads of a mobile workforce is that many individuals who leave their jobs are faced with decisions about what to do with their 401(k) accounts.¹ How do you navigate the advantages and disadvantages of your options? What are the tax implications? Are there penalties? These are all important questions.
Effectively, individuals have four choices for 401(k) accounts they funded while working for previous employers.2 Here are the options:
Option 1: Leave It with Your Previous Employer
You may choose to do nothing and leave your account in your previous employer’s 401(k) plan. However, if your account balance is under a certain amount, be aware that your ex-employer may elect to distribute the funds to you (potentially causing tax/penalties) or may request that you move the funds out of the plan.
There may be reasons to keep your 401(k) with your previous employer, such as investments that are low cost, creditor protections that are unique to qualified retirement plans, or to retain the ability to borrow against your balance if the plan allows for loans to ex-employees.3
The primary downside is that individuals can become disconnected from old accounts and pay less attention to the ongoing management of investments, which can leave accounts vulnerable to disproportionate or inappropriate allocations. Some plans also have very limited investment menus.
Option 2: Transfer to Your New Employer’s 401(k) Plan
If your new employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you may consider moving these assets to your new plan.
The primary benefits to transferring are the convenience of consolidating your assets, retaining creditor protections, and keeping them accessible via the plan’s loan feature.
If the new plan has a competitive investment menu, many individuals prefer to transfer their account and make a full break with their former employer.
Option 3: Rollover Assets to an Individual Retirement Account (IRA)
Another choice is to roll assets over into a new or existing IRA. It’s possible that an IRA may provide more investment choices that may not exist in the 401(k) plan.4 This option also allows you to actively manage your investments by working with a financial professional.
The drawback to this approach may be less creditor protection and the loss of access to these funds via a 401(k) loan feature.
You may want to seek professional guidance to answer questions you may have. Your financial advisor will likely have ideas that fit specifically to your personal situation, especially if you become self-employed.
Option 4: Cash out the account
The last choice is to simply cash out of the account. However, if you choose to cash out, you may be required to pay ordinary income tax on the entire balance on top of a 10% early withdrawal penalty if you are under age 59½. In addition, employers may hold onto 20% of your account balance to prepay the taxes you’ll owe.
Think carefully before deciding to cash out a retirement plan. Aside from the costs of the early withdrawal penalty, there’s an additional opportunity cost in taking money out of an account that could potentially grow on a tax-deferred basis. For example, taking $10,000 out of a 401(k) instead of rolling over into an account earning an average of 8% in tax-deferred earnings could leave you $100,000 short after 30 years.5
If you or a loved one has questions about what might be best, don’t hesitate to reach out. We’re happy to discuss your options with you as it relates to your personal situation.
1 In most circumstances, you must begin taking required minimum distributions from your 401(k) or other defined contribution plan in the year you turn 72. Withdrawals from your 401(k) or other defined contribution plans are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty.
2 FINRA.org, 2022
3 A 401(k) loan not paid is deemed a distribution, subject to income taxes and a 10% tax penalty if the account owner is under 59½. If the account owner switches jobs or gets laid off, any outstanding 401(k) loan balance becomes due by the time the person files his or her federal tax return.
4 In most circumstances, once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA). Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. You may continue to contribute to a Traditional IRA past age 70½ as long as you meet the earned-income requirement.
5 This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Please view the Investor Alerts section of the FINRA website for additional information.