401(k) Retirement Plan Choices for Job Changes
Photo Credit: Denys Nevozhais, Unsplash
There are many different reasons for changing jobs. Whatever the reason for the change in employment, this circumstance offers the ideal chance to review your long-term financial strategy. After all, this is one of the few instances, apart from when you actually retire, that you will need to decide how to use the money you have accumulated in your retirement 401(k) plan.
Assessing your situation during this transitional period might make you feel better about your new employment and can help you refocus on your long-term savings strategy.
When you leave an employer, you are likely to have several options, which include:
■ Stay invested in your previous employer’s plan if your balance meets the plan’s minimum
■ Invest your assets in the new employer’s plan
■ Take your distribution in cash
■ Roll over assets to an IRA
While making choices, look at your existing plan in its entirety:
■ Be aware of any financial penalties related to taking a cash distribution
■ Look at all the plan criteria
■ Confirm that the new IRA or plan provides investing and payout choices that meet your needs.
Contrast the costs, benefits, and services of the retirement plan from your former job with those of the one from your current workplace and a rollover IRA. Your money can grow tax-deferred if you do a direct rollover since you won't be charged any current taxes or penalties.
Choice 1: Stay Invested In Your Previous Employer’s Plan
You may often keep the money where it is unless your balance is below the minimum cash-out amount for the plan. It would help if you reflected on the following issues:
Am I satisfied with the investments I made?
Am I restricting my use of these resources now that the company no longer employs me?
Does this plan allow for after-tax contributions?
You may be happy with the performance of the assets in your former company's plan or with investments that you might not have access to in your new employer's plan. Additionally, your employer might cover some account expenses, making an employer plan more affordable than alternatives like an IRA. A 401(k) may receive two different after-tax contribution 401(k) forms. A Roth 401(k) is one of them. Withdrawals from a Roth 401(k) are tax-free if you abide by certain IRS regulations, just like with a Roth IRA. The additional after-tax contributions you can make to such plans may grow tax-deferred, but any potential gains are subject to withdrawal taxes. Rolling the contributions into a Roth IRA is a good idea if you have this after-tax money. Qualified withdrawals from a Roth IRA are tax-free.
Look at the big picture, including any adjustments you may have made to your financial strategy, before deciding to shift your nest egg. While there are various benefits to keeping the money in place, your former employer's plan should align with your updated financial strategy.
Choice 2: Invest Your Assets in Your New Employer’s Plan
Imagine that after reviewing the retirement plan that your new employer offers, you decide to transfer your assets because it is a good fit for your long-term objectives. By doing this, you can keep your retirement funds tax-deferred. Also, it will keep all of your assets in one place.
That is the good news. The bad news is that you might need more time to participate in your new employer's plan. Before new workers can join some programs, they must fulfill a service requirement (of up to one year of service). Some plans let new workers make rollover contributions to the plan even if they still need to fulfill the eligibility conditions for beginning salary deferral payments. But, if the plan prohibits rollovers and you want to transfer assets as soon as you leave your current employment, this might be an issue. As you wait the necessary amount of time to transfer pretax assets into your employer's new plan, you can consider rolling your funds into a rollover IRA (See Choice 4).
Choice 3: Take Your Distribution in Cash
Assume you have diligently saved and are close to building a decent retirement nest egg. But it is alluring to have the option of taking that income when you change jobs. Consider a few things before having a check for the entire distribution (or even just a portion) made out to you.
You may give the government approximately one-third of your account if the check is in your name. The employer automatically withholds 20% of a payout for federal taxes when it is collected in cash and not instantly rolled over into an IRA or another qualifying plan.
A 10% extra federal tax penalty might be imposed on you if you are under 59 1/2. But, if you leave the military after turning 55, this penalty tax does not apply. For taxpayers with a 22% or higher tax rate, the already-dwindling nest egg will decline by at least another 2%. In other words, you risk jeopardizing your savings plan for a decent retirement.
You still have the option to roll the dividend into an IRA or another plan after accepting the cash payment. To avoid taxes, you must reinvest 100% of the payout—including the portion withheld for taxes—within 60 days of the distribution date.
You should carefully consider your hard work and sacrifices before accepting the distribution because you will now be taxed and penalized for them. And if you are still on the fence, talking it over with your financial advisor may help address any remaining concerns about how even a small cash distribution will affect your retirement income.
Choice 4: Roll Your Assets Into An IRA
Rolling over assets to an IRA may provide the most investing freedom and less exposure to taxes and penalties than taking cash out of the four distribution options outlined here.
A lump-sum dividend is deposited into an IRA or another qualified plan via a direct rollover. When changing jobs, you should obtain a check made payable to the trustee of the new plan or IRA for the amount you intend to roll over from your 401(k) (qualified plans include 401(k), 403(b), pension, and profit-sharing plans). Please be aware that the check should only be made out to you if you receive the cash distribution.
Once the rollover is complete, you can leave your funds in the IRA or later decide to transfer them to a new employer's plan whenever you are qualified to do so. But, keep in mind that there can be charges for opening and terminating the IRA and that indirect IRA rollovers (when an IRA has released payment to you and is then redeposited in a plan or IRA within 60 days) are only permitted once every 12 months.
The key is to roll your assets into a vehicle that provides a wide range of investment options that fit your financial goals. For regular IRAs, mutual funds are among the most popular options. Diversifying IRA holdings among mutual funds provides investors with skilled, full-time management, risk reduction via diversification, and the freedom to switch between funds as their investing needs change. But keep in mind that the principal value and return of mutual funds can fluctuate with changes in the market and that, upon withdrawal, your investment may be worth more or less than you paid for it initially.
Take Your Time and Invest Wisely
When you change jobs, you must make a crucial financial choice regarding your 401(k) assets. When presented with these four options, properly consider your options.
Creditor protection is one advantage of retirement funds. Most of the time, you won't have to decide immediately, giving you plenty of time to consult a financial counselor or investing expert. They can offer advice on how to invest those resources to try to increase your retirement income.
Depending on the kind of account and, in some situations, state legislation, the amount of protection will change. A federal statute safeguards qualifying plans, such as 401(k)s, from taxation (ERISA). Thanks to this, your 401(k) is shielded against nearly all demands by creditors, bankruptcies, and court rulings (the IRS and divorce proceedings are two exceptions). While an IRA does not have the same federal protection against creditors or court judgments, it does provide similar protection if you file for bankruptcy. An IRA may get additional protection from your state.
An IRA rollover has benefits and drawbacks based on your financial circumstances and retirement objectives, investment alternatives, services, costs and fees, withdrawal options, mandated minimum distributions, and tax treatment. While the underlying funds may be subject to sales loads, increased management fees, 12b-1 costs, and IRA account expenses, please be aware that rolling over retirement assets into one IRA account might raise fees. Consult your investment advisor for advice on whether a rollover to an IRA suits you.
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
Portions of this article were sourced from the work of MFS Heritage Planning. Neither MFS nor any of its subsidiaries are affiliated with Optima Capital Management.
Our Insights
