Leaving a job, whether planned or unexpected, can trigger questions about your 401(k) plan. It’s natural to feel unsure about navigating your options amidst the transition.
As financial planners, we regularly meet individuals at life’s crossroads. Whether it’s selling a business, navigating a divorce, or embarking on a new career chapter, these milestones prompt financial reevaluation. Often overlooked, however, is the significant transition of a job change. While moving on quickly is understandable, it’s crucial to manage your retirement savings effectively.
Whether your departure was your choice or a detour on your career path, it’s likely filled with emotions. Like ending a long-term commitment, you’ve built connections, made plans, and envisioned a future. But just like any ending, it’s time to embrace what’s ahead. And amidst the excitement of new beginnings, don’t let your retirement savings fall by the wayside.
One of the most common frustrations we hear from new clients is scattered retirement accounts. After job changes and life chapters, accumulating multiple accounts and neglecting older ones is easy.
If any of this sounds familiar to you, here are some tips to keep your employer-sponsored retirement plans on track (and maybe find some zen in the process).
Know where your money flows.
Make a list of all your past jobs. Track down all those retirement accounts, no matter how small.
Know what you’re entitled to.
If you leave your job (voluntarily or involuntarily), you’ll be entitled to a distribution of your vested balance. Your vested balance always includes your own contributions (pre-tax, after-tax, and Roth) and typically any investment earnings on those amounts. It also includes employer contributions (and earnings) that have satisfied your plan’s vesting schedule.
In general, you must be 100% vested in your employer’s contributions after three years of service (“cliff vesting”), or you must vest gradually, 20% per year until you’re fully vested after six years (“graded vesting”). Plans can have faster vesting schedules, and some even have 100% immediate vesting. You’ll also be 100% vested once you’ve reached your plan’s normal retirement age.
It’s important for you to understand how your particular plan’s vesting schedule works because you’ll forfeit any employer contributions that haven’t vested by the time you leave your job. Your summary plan description (SPD) will spell out how the vesting schedule for your particular plan works. If you don’t have one, ask your plan administrator for it. If you’re on the cusp of vesting, it may make sense to wait a bit before leaving, if you have that luxury.
Don’t spend it.
While this pool of dollars may look attractive, don’t spend it unless you absolutely need to. If you take a distribution you’ll be taxed, at ordinary income tax rates, on the entire value of your account except for any after-tax or Roth 401(k) contributions you’ve made. And, if you’re not yet age 55, an additional 10% penalty may apply to the taxable portion of your payout. Unless an exception applies.
If your vested balance is more than $7,000, you can leave your money in your employer’s plan at least until you reach the plan’s normal retirement age (typically age 65). But your employer must also allow you to make a direct rollover to an IRA or to another employer’s 401(k) plan (if permitted by that plan). As the name suggests, in a direct rollover the money passes directly from your 401(k) plan account to the IRA or other plan.
In some cases, you have no choice — you need to use the funds. If so, try to minimize the tax impact. For example, if you have nontaxable after-tax contributions in your account, keep in mind that you can roll over just the taxable portion of your distribution and keep the nontaxable portion for yourself.
Know your options.
Now for the big question, “should I roll over to my new employer’s 401(k) plan or to an IRA?” Assuming both options are available to you, there’s no right or wrong answer to this question. You need to weigh all the factors and decide based on your own needs and priorities. It’s best to have a professional help you with this since the decision you make may have significant consequences — both now and in the future.
2. Reasons to consider rolling over to an IRA:
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- IRAs typically offer a wider range of investment options compared to employer-sponsored 401(k) plans. This means you have more flexibility to choose investments that align with your individual risk tolerance and financial goals.
- With an IRA, you generally have the freedom to move your money around between different investments as often as you’d like. This allows you to adjust your portfolio over time based on market conditions and your evolving financial priorities. In contrast, employer-sponsored plans often have limited investment options and may restrict how frequently you can make changes.
- An IRA may give you more flexibility with distributions. Your distribution options in a 401(k) plan depend on the terms of that particular plan, and your options may be limited. However, with an IRA, the timing and amount of distributions are generally at your discretion (until you reach the age at which you must begin taking minimum distributions).
- If your former employer shuts down in the future due to bankruptcy, it could be very challenging to take distributions from your 401k or roll it over to an IRA since there is no longer a contact at the company to authorize doing so. While the Department of Labor has an “orphaned plan” program for these cases, it can be a lengthy process to ultimately get control of your savings.
- You can roll over (essentially “convert”) your 401(k) plan distribution to a Roth IRA. You’ll generally have to pay taxes on the amount you roll over (minus any after-tax contributions you’ve made), but any qualified distributions from the Roth IRA in the future will be tax free.
2. Reasons to consider rolling over to your new employer’s 401(k) plan (or stay in your current plan):
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- While some employer-sponsored plans allow participants to borrow against their funds, IRAs do not. This means accessing your IRA money typically involves taking a distribution, which can incur taxes and penalties before age 59½. However, there is a limited “60-day rollover” strategy you can utilize once per year. This involves taking a distribution from your IRA and then depositing the same amount back within 60 days. Essentially, you’re giving yourself a short-term loan from your retirement savings, but it’s crucial to adhere to the strict timeframe to avoid tax consequences. Ultimately, employer-sponsored plans offer more borrowing flexibility, while IRAs prioritize protecting your retirement savings through stricter access rules.
- If your distribution includes Roth 401(k) contributions and earnings, you have two options for tax-advantaged rollovers. You can move them to a Roth IRA, where they’ll follow the IRA’s five-year holding period for tax-free qualified distributions. This means if you’re new to Roth IRAs, the five-year clock starts ticking from the rollover date. Alternatively, you can roll them into your new employer’s Roth 401(k) plan (if it accepts rollovers). In this case, the existing five-year holding period from your previous plan carries over, potentially allowing you to access tax-free qualified distributions sooner.
3. What about outstanding plan loans?
In general, if you have an outstanding plan loan, you’ll need to pay it back, or the outstanding balance will be taxed as if it had been distributed to you in cash. If you can’t pay the loan back before you leave, you’ll still have 60 days to roll over the amount that’s been treated as a distribution to your IRA. Of course, you’ll need to come up with the dollars from other sources.
Before rolling over your 401(k), take some time to weigh the decision carefully. Consider these key factors:
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- Fees and Expenses: Compare the investment fees and expenses of your IRA options (including any underlying investment funds) to those of your current employer plan. Minimizing fees can significantly impact your long-term retirement savings growth.
- Surrender Charges: Both your employer plan and your chosen IRA might have surrender charges for early withdrawals. Research these potential penalties to avoid unexpected tax implications.
- Guaranteed Benefits: Carefully evaluate any accumulated rights or guarantees, such as employer matching contributions or life insurance benefits, which you might forfeit by rolling over your funds.
Have a plan, not panic.
Having a comprehensive financial plan can help in scenarios like this. That includes regularly reviewing your retirement savings and investment strategy to make sure it’s still aligned with your evolving goals and circumstances.
Bottom line, changing jobs doesn’t have to derail your retirement plans. You can make smart financial decisions with the right tools and support.
So, know your options, make informed choices, and seek guidance to help you simplify your financial life. My team and I are in the business of helping people. If you want some help untangling your financial life, please get in touch.
Securities offered through Raymond James Financial Services, Inc., member FINRA / SIPC. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. Bend Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services. Any opinions are those of Stuart Malakoff and not necessarily those of RJFS or Raymond James. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Some of the following material has been prepared by Broadridge Investor Communication Solutions, Inc.
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