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Most of us change or leave jobs multiple times over the course of our careers. Recent events have forced these transitions for some of us. But one thing that often gets forgotten is the 401(k). Have you left a trail of old 401(k)s with your name on them at former employers? You’d be surprised how many people do.
When you change jobs or leave a company, you have options. You can:
There are pros and cons to each, but first, make sure you understand the differences between these types of retirement savings options. And before you decide what to do with your 401(k), be sure to discuss your options with a financial professional who can help you avoid the common pitfalls of a 401(k) rollover.
While they’re all retirement savings plans, there are important distinctions between them.
A 401(k) is an employer-sponsored retirement account. When you work for a company that offers a 401(k), you can contribute money and your employer often makes matching contributions, up to a certain amount, which helps your 401(k) grow even faster.
There are two types of 401(k)s:
An IRA is an individual retirement account. You can open an IRA with the help of a financial professional. The IRA is invested in mutual funds, stocks, bonds, and more. Your financial professional will work with you to determine your financial goals and assess your risk tolerance when selecting these investments.
There are two common types of IRAs:
Please note: It is important to not take distributions from an IRA before age 59 1/2 to experience the full benefits of these tax-advantaged accounts. For this reason, we recommend that you have six months’ worth of living expenses put away in an emergency savings fund prior to investing in an IRA.
Both IRAs and 401(k)s offer a convenient way to save for retirement. But if you’ve left a company and are no longer contributing to their 401(k), many experts recommend that you roll that money into an IRA. It’s all about choice.
The investment options you have within a 401(k) are determined by your employer. Some offer a wider variety of fund options than others, but they’re always limited. In comparison, you have almost unlimited choices in how you want to invest the money in your IRA. In fact, having better investment choice is the biggest reason people choose to rollover their 401(k) to an IRA.
A retirement plan rollover is a transaction where you transfer your investment savings from one plan, such as a 401(k), to another, such as an IRA. When you transfer directly from a traditional 401(k) to a traditional IRA, or from a Roth 401(k) to a Roth IRA, you will pay no tax. Plus, there's no limit on how much money you can roll from a 401(k) into an IRA.
With a direct rollover, your money is transferred from one account to the other; you never touch it. This process is tax-free and requires no withholding. You can do a direct rollover at any time for any amount, and there is no limit to the number of direct rollovers you can do in a year.
Indirect rollovers require more work. With this option, the 401(k) administrator from your old employer will send you a check made payable to you, and you are then responsible for making sure the money gets deposited into your new IRA within 60 days.
In addition, you will be subject to withholding. Typically, your old 401(k) will withhold 20 percent when you ask for an indirect rollover. You can get that back in the form of a tax credit when you file your tax return, but in the meantime, you must come up with the remaining 20 percent yourself and deposit it into the IRA within 60 days if you want to avoid any taxes or penalties. If you don’t complete the full deposit within 60 days, you will owe tax on the amount that was not deposited into your IRA. You are limited to just one indirect rollover per year.
Once you leave a company, most 401(k) plan administrators allow you to leave your money in the plan if the balance is above a minimum balance, usually $5,000. If your 401(k) totals less than $1,000, though, the plan administrator will typically write you a check and close your 401(k).
If your old plan has low fees, and if you like the investment options that are available to you, you may want to keep your money where it is. However, be sure to compare the fees to those of an IRA, which are typically low.
This option also takes more coordination. If you get married or move, or if you need to make a change in your beneficiaries, you’re responsible for notifying the plan administrator. You’ll also need to check your investment allocations regularly, to make sure they continue to meet your overall financial goals.
If your 401(k) includes employer stock that has appreciated over time, you may want to consider leaving the 401(k) as is, due to a rule regarding something called net unrealized appreciation (NUA). NUA situations qualify for special tax treatment, depending on how long you’ve owned the stock. However, these NUA benefits cannot be applied if you roll the stock over to an IRA or another 401(k).
If your new employer allows rollovers, and if the new 401(k) has low fees and investment options that work for you, you may want to consider rolling your old 401(k)s into the new one. But again, an IRA typically has lower fees and almost unlimited investment options, so make sure this option meets your needs.
A direct rollover from one 401(k) to another can also take weeks, so you’ll need to track the status of the transfer. And some employers require a waiting period before you’re eligible for this option.
This should be a last resort, used only if you're facing severe financial hardship. You will be taxed on the distribution, and you will be charged an early withdrawal fee. Altogether, you could lose as much as 40 percent of your fund to taxes and fees.
If you need money, check to see if your existing 401(k) plan allows you to borrow against the fund instead.
While there are many good reasons to rollover your 401(k) to an IRA, there are a few important things to consider.
There are a lot of good reasons to rollover your old 401(k) to an IRA. How do you know if this is the best choice for you? That’s where we can help.
An Alaska USA Financial Planning and Investment Services financial professional can help you evaluate your options, and if it makes sense, develop a customized investment plan that will put your IRA money to work for you. Schedule a complimentary, no-obligation consultation today!
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