Managing Your 401(k) Through A Job Transition
Photo Credit: Emile Guillemot
Many of us may work at several companies during our professional careers. When transitioning jobs, consider the implications for your old 401(k) carefully. Preserving the tax benefits of your investments may substantially improve your ability to grow your wealth over time. Below are five options to consider when transitioning your retirement funds during a change of employment.
Keep It with Your Former Employer
After separating from service, your former employer may allow you to leave the money in the 401(k) plan. In this situation, your retirement money is still yours, and you will have the ability to roll it over or make a withdrawal from your 401(k) account at any point in the future. Additionally, your retirement savings will continue to grow tax-deferred, and you will not have to pay any taxes until you begin to withdraw.
Multiple 401(k) accounts can complicate managing your overall investment asset allocation and keeping your beneficiary information current. Unfortunately, there is a chance that your company's plan sponsor will charge your old 401(k) additional administrative and investment fees since you are no longer an active employee. Furthermore, you will no longer be able to make new contributions of your own to help your retirement savings grow. Your account may also need to have a minimum balance.
Roll Your Assets into Your New 401(k)
It should be reasonably easy to compare and contrast the two 401(k) plans and choose the one that best meets your needs. Your new 401(k) may cost less or give you access to better investment options. Also, your required minimum distributions (RMDs could be postponed until you turn 72 if you are still working at the new company. Your retirement account will continue to grow tax-deferred.
Your new 401(k) plan will need to be able to accept rollovers, and the process will require that you liquidate all of your current investments in the old account. Keep in mind that your new plan may have different restrictions regarding your ability to make in-service withdrawals before retirement or have the capability to take out a loan from your account.
Roll Your Assets to an IRA
To access additional investment options such as individual stocks and ETFs, you should consider rolling over your old 401(k) to a traditional individual retirement account (IRA). An IRA will preserve the tax-advantaged status of your retirement assets, and your account will not be tied to any employer. In addition, you will usually have greater access to your savings, although income taxes and possible early withdrawal penalties may apply if you are under age 59 1/2.
Traditional IRAs are also subject to required minimum distributions or RMDs. These RMDs will begin at age 72, whether or not you are currently working. A traditional IRA will remain uninvested without an advisor or specific action you take.
Convert to a Roth IRA
A key difference between 401(k)s and Roth IRAs is that 401(k)s are funded with pre-tax dollars vs. Roth IRAs, which are funded with after-tax dollars. Additionally, current US tax law states that Roth IRAs are exempt from required minimum distributions, which generally occur in the year that you turn age 72.
When converting a 401(k) into a Roth IRA, you must pay taxes on the conversion amount. Depending on your tax bracket, you may find yourself in a lower income tax bracket in the year of the conversion. This conversion may allow you to pay lower taxes overall since the money converted will now be able to grow tax-free inside a Roth IRA.
After you have retired, any distributions from your Roth IRA will not be taxed, assuming that you are 59 1/2 or older and have had your account for a minimum of 5 or more years. Taking money before these requirements without an exemption will result in a 10% tax penalty from the IRS.
Cash Out Your Account
Cashing out your old 401(k) means immediate access to your assets. Taking your money out means liquidity for living expenses, which should be the primary reason for taking this action.
However, cashing out your account can have significant financial consequences. There is a mandatory 20% withholding on the distribution, a possible state tax withholding, and the amount distributed would be considered additional ordinary income. In addition, a distribution may be subject to a 10% early withdrawal penalty if you are under age 59 1/2. Some exceptions may apply.
As always, we recommend that you consult with your financial advisor and tax professional when making these decisions.
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