It is very common for me to see a new client with a number of old 401(k) accounts held by various former employers. Many people don’t know what to do with the accounts when they leave a job, but you actually have several options, including the three listed below:
1. Leave the account with your old employer. If your balance is at least $5,000, you are entitled to do this, and your former company must allow it. If your balance is below $5,000, your employer is not obligated to let you leave your money in the plan. Your best bet is to contact your old employer’s plan administrator to learn what options you have upon terminating employment.
Why might you leave your 401(k) with your former employer?
- The plan you are leaving has a number of solid, low-cost investment options, and the overall plan fees are reasonable.
- You are considering rolling your balance over to a new employer’s plan at some point. You must not comingle an old 401(k) balance with any other retirement funds if you want to roll it over to a new plan. Leaving your account intact at an old employer is one method that will let you leave your options open.
2. Roll the balance into an IRA account. You are free to roll your 401(k) balances (and balances of most other plans) to an IRA at a mutual fund company, bank, brokerage firm, and so on. Assuming you want to retain the tax-deferred nature of the account, be sure to do a trustee-to-trustee transfer. This means a distribution is not made to you, but rather it is made to the new custodian of the account. If you do take a distribution, your employer is obligated to withhold 20 percent federal tax. If you then decide you would like to roll the money over to an IRA, you have 60 days and you must come up with the 20 percent that was withheld in order to preserve the full tax-deferral of the account.
Why would you want to roll your 401(k) into an IRA?
- The investment options in your former employer’s plan are so-so at best.
- The IRA will provide greater flexibility in the investment choices available.
Please note that if your desire is to ultimately roll your old 401(k) balance into a plan at your new employer, you can still roll your old plan into an IRA. However, you need to ensure these dollars and any earnings from them remain completely separate from any other money. If the funds are “tainted,” then you lose the ability to roll them into a new 401(k) plan.
3. Tax considerations for your 401(k)All contributions made with pre-tax dollars (income on which you have never been taxed) are subject to taxation at ordinary income tax rates upon withdrawal. In addition, if you are under 59 ½ and do not meet the specific exceptions to this rule, your withdrawal will be subject to an additional 10 percent penalty upon withdrawal from your retirement plan.
Other retirement account considerations
- Company retirement accounts offer a high degree of protection from creditors. In most states, IRAs have similar protections. If asset protection is an issue for you, please consult with an expert in this area.
- If your 401(k) account is a Roth account, it is eligible to be rolled into a Roth IRA.
- A non-Roth retirement account will need to first be rolled to a traditional IRA and then converted to a Roth IRA. This is a taxable event.
- If your account is a mix of pre-tax and post-tax contributions, you will need to quantify these amounts. Consult the custodian on the rollover IRA and your financial advisor for assistance here.
This is not an exhaustive list. Dealing with a retirement plan account from an old employer is complex. If you are in this situation, this is an excellent time to engage the services of a qualified financial advisor. If you choose to go it alone, make sure you do your research and know the rules.
Roger Wohlner, CFP® is a fee-only financial advisor at Asset Strategy Consultants. Roger provides advice to individual clients, retirement plan sponsors and participants, foundations, and endowments.
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