Choices for Your 401(k)

401(k)In our culture of continual job change, people who leave their jobs are faced with a decision about what to do with their 401(k) account. Indeed, a 2012 report by the U.S. Labor Department notes that the average worker holds 11 jobs from age 18 to 46. How many previous employer 401(k)s and company plans do you have, and are you keeping track of them?

Probably the biggest mistake you can make when leaving a job is cashing out your old 401(k). According to a 2012 report by Transamerica Center for Retirement Studies, 25 percent of unemployed or underemployed workers did just that. Often times people, especially younger employees, see their retirement dollars as a windfall to spend. They leave a company and cash out whatever dollars they saved in their retirement accounts. Not only does this create taxable income and a 10 percent penalty, but it puts them behind in their retirement savings.1 It is difficult to make up that savings deficit as people get older. Here are the three most viable choices:

 

Choice 1: Leave it with your previous employer

According to the Labor report above, 22 percent of people who left a job kept their 401(k) money where it was, and 20 percent rolled their accounts into an IRA. 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.

The main reason this choice is made is simply neglect and lack of attention. Many people forget and become disconnected from the past account and neglect to manage and watch the investments. However, sometimes people choose to maintain their previous plan because of their satisfaction with the investments and possibly lower fees of the plan. Other reasons are to maintain certain creditor protections that are unique to qualified retirement plans, or retain the ability to borrow from it, if the plan allows for such loans to ex-employees.²

 

Choice 2: Transfer to your new employer’s 401(k) plan

Provided your current employer’s 401(k) accepts the transfer of assets from a pre-existing 401(k), you may want to consider moving these assets to your new plan. The primary benefits to transferring are the convenience of consolidating your assets, retaining their strong creditor protections and keeping them accessible via the plan’s loan feature. Provided your new plan has a competitive investment menu, many individuals prefer to transfer their account and make a full break with their former employer.

You can certainly transfer your old 401(k) to the new 401(k) if you’re happy with your new employer’s plan and options. Consult with your new human resource department to confirm that rollovers are permissible. Keeping all your retirement assets in one account can make it easier to manage and keep track of.

 

Choice 3: Roll over to a traditional individual retirement account (IRA)

The last choice is to roll it over into a new or existing traditional IRA.³ A traditional IRA may provide a wider range of investment choices than what may exist in your new 401(k) plan. Flexibility is one of the greatest benefits of a rollover. Once you have rolled your retirement assets to your IRA you work directly with the Investment Institution and advisor that holds your IRA, no longer going through your previous employer’s HR department. Many times the rollover and access to your money can take 60 days and longer due to inefficiencies and employer “sign off” to release your funds. You will have better access many times in a personal IRA and may be happy you consolidated your previous 401k(s) to manage your investments. One drawback to this approach may be less creditor protection and the loss of access to these funds via a 401(k) loan feature, which is typically not available to ex-employees of the company that sponsors the 401k.

 

Things to remember

Figure out where you can get the most attractive investment options. Generally, 401(k) plans offer a limited array of investment options while IRAs offer a much greater diversity of investment choices. In some cases, large employers use their bargaining power to select investments that have lower fees than what you could find on your own in an IRA. However, some 401(k)s have poor investments with abnormally high fees, in which case you’d be better off moving the money into a different account.

Roll over the money directly to the new financial institution. It’s a good idea to have your rollover paid directly to the new retirement plan (IRA). If the 401(k) balance is paid to you, 20 percent of the balance will be withheld for income tax. Then you will have 60 days to put the entire distribution, including the withheld 20 percent, into a new retirement account. If you fail to make the deposit within two months, you will have to pay income tax, and if you’re under age 59 1/2, you will have to pay the early withdrawal penalty.

Watch out for vesting schedules. While you always get to keep the money you contribute to a 401(k) plan, you don’t get to keep your employer’s contributions until you are vested in the plan. Find out when you become vested in your current 401(k) plan before you leave your job. Depending on the dollar amount, it may make sense to wait until you vest. But you may not want to miss an opportunity for a small dollar amount if it is not significant.

Making the right decision for your 401k from a previous employer is extremely important. Don’t feel rushed into making a decision. You have time to consider your choices and may want to seek professional guidance and an advisor to answer any questions you may have.

 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

  1. Distributions from 401(k) plans and most other employer-sponsored retirement plans are taxed as ordinary income and, if taken before age 59½, may be subject to a 10 percent federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.
  2. A 401(k) loan not paid is deemed a distribution, subject to income taxes and a 10 percent penalty tax if the account owner is under 59½. If the account owner switches jobs or gets laid off, the 401(k) loan becomes immediately due. If the account owner does not have the cash to pay the balance, it will have tax consequences.
  3. Withdrawals from traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10 percent federal income tax penalty. Generally, once you reach age 70½, you must begin taking required minimum distributions.

 

Jeffery Masters is president of Jeffery W. Masters & Associates at 954-977-5150. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Independent Financial Partners, a registered investment advisor. Independent Financial Partners and Jeffery W. Masters & Associates are separate entities’ from LPL Financial – [email protected]

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