I recently had a client leave their employer, a local hospital here in Grand Rapids, to start their own business. In light of this change, we discussed the options for their retirement plan as my client began his quest through entrepreneurship. Whether you’re making a career change or just got laid off, your 401(k) may be at the bottom of your to-do list. However, moving your 401(k) is an incredibly important step that must be well-thought-out. When leaving an employer, there are typically three workable opportunities to continue the growth of your retirement funds. Understanding which route offers more advantages for continued growth that will align with your next chapter in life is the first step.
You will have the option to roll your retirement plan to your future employer, roll the funds to an IRA, leave the money in the former employer plan, or simply cash it out. The latter usually being the least desirable option, as it could trigger significant taxes and a 10 percent early withdrawal penalty. Furthermore, we've often come across clients who neglected to monitor their old 401(k) plans and the target asset allocation became substantially off balance over time. Whatever option you choose, make sure to weigh the costs, taxes, investments, and overall plan before coming to a conclusion.
Before you make your decision, gather any appropriate account statements and contacts. When you signed up for the initial retirement plan, you may have selected both a traditional 401(k) and a Roth 401(k) but keep in mind, these are two separate accounts. Traditional 401(k) contributions are not taxed but are subject to penalties in the case of early withdrawal. Roth contributions, on the other hand, are taxed but withdrawals have no adverse effect as long as the distribution is considered qualified by the IRS.2
You‘ll want to choose the right type of retirement account and avoid paying taxes or penalties for potentially choosing a plan that isn’t right for you. For example, if you decide to roll your 401(k) into a Roth, you should prepare to pay taxes on the full amount.
Review your previous employer’s plan and weigh the benefits of your new employer’s retirement plans. More importantly, make sure the necessary steps are taken to move your funds with limited repercussions. If you're working with an advisor and decide to roll the money to an eligible IRA or Roth IRA, the advisor should be experienced to guide you through the process without trouble.
If you leave money in your previous employer’s plan, it’s a good idea to have an advisor review the plan’s progress over time. If you decide to transfer funds, the previous plan’s administrator can often send the check to a designated contact. Working with your advisor will be beneficial as they can coordinate such transactions.
Depending on the length of your previous employment, it’s a good idea to also check the associated vesting schedules. Vesting schedules are tied to the employer’s contributions and determine the amount and date when the employer’s contributions are legally yours. Your own contributions are fully vested from day one.
Age is another contributing factor when deciding how to approach a former employer’s 401(k). For instance, if you quit a job, are laid off or fired the year you turn 55, you may withdraw funds penalty-free from the 401(k) established through that employer only.3 If you choose to roll the funds over into another 401(k) or IRA, you will need to wait to withdraw those funds until age 59½ in order to avoid the 10 percent withdrawal penalty. In addition, this penalty-free withdrawal does not count for 401(k) accounts established through previous employers. It only is eligible in regards to the account established with the employer you've left at age 55 or older. If you're unsure about what options may be right for you, talk with a financial advisor to help ease your concerns and help you avoid costly mistakes.
It’s important to also keep in mind that your new employer may have a waiting period before you’re able to rollover funds. In this case, your advisor may suggest that you open an investment account to continue contributions during the waiting period. Opening another account allows you to take advantage of the tax deduction until you make your final decision. Keeping investment growth active could be more beneficial for you in the long run.
Michael Steinebach is a Financial Advisor serving the Greater Grand Rapids area. Born and raised in Rockford, Michigan, Michael is a focused on helping individuals in the community make prudent choices with their money.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.