Options for an old 401(k)

Changing or leaving a job can be very emotional. You’re probably happy for a new opportunity but you can also be nervous. As you leave your workplace, don’t forget about your 401(k) or 403(b) with your employer. You have several important decisions.

Your 401(k) may be a big portion of your retirement savings, it’s key to weigh the pros and cons of your options first.

1. Keep your 401(k) with former employer

Most companies allow you to keep your retirement savings in their plan after you leave.

Benefits:

  • Your money can continue to grow tax-deferred.
  • You can take penalty-free withdrawals if you’re 55 or older and leave your job.
  • Federal law provides protection against creditors.

Cons:

  • If you have less than $5,000 in the plan, your money can be automatically sent to you or an IRA for you.
  • After you reach age 72, you’ll have to take RMDs from a traditional 401(k).
  • Withdrawals options may be limited. For example, you may not be able to take a partial withdrawal, you’ll have to take the entire balance.
  • If you choose to keep the money in your former employer’s plan, you can’t add any more money to the account, or, in most cases, take a 401(k) loan.

2. Roll over the money into an IRA

A rollover IRA is a retirement account that lets you move money from your former employer retirement plan, into an IRA. 

You can open the IRA with a bank or brokerage firm. Make sure to research the fees and expenses when choosing an IRA.

Benefits:

  • Your money has a chantance to grow tax-deferred.
  • If you’re under 59 ½ , you can withdraw money without penalty for a first-time home purchase or higher education expenses.
  • You may be able to get a wider range of investment choices than is available in an employer’s plan.

Cons:

  • After you’re 72 years old, you’ll have to take annual required minimum distributions from a traditional IRA (not Roth IRA) every year, even if you’re still working.
  • Federal law offers more protection for money in 401(k) plans than in IRAS. Some states offer certain creditor protections for IRAs too.

The CARES act temporarily waives RMDs for all types of retirement plans for year 2020. This includes the first RMD, which individuals may have delayed from 2019 to April 1, 2020.

 3. Roll over your 401(k) into a new employer’s plan

Not all employers accept rollovers from a previous employer’s plan, so you should check in with your new employer first.

Benefits:

  • Your money has a chance to continue to grow tax-deferred.
  • Having one 401(k) can make it easier to manage your retirement savings
  • Many plans have lower-cost or plan-specific investment options.
  • Federal law provides broad protection against creditors. You can also defer RMDs even if you’re working after age 72.

But:

  • You need to make sure to understand your new plan rules
  • Consider the range of investment options available in the new plans

4. Cash out

Taking the money out of retirement accounts altogether shouldn’t be done unless the immediate need for cash is critical. The consequences vary depending on your age and tax situation. If you withdraw before age 59 ½ from your 401(k), the money will be generally subject to both ordinary income taxes and a potential 10% early withdrawal penalty. (An early withdrawal penalty doesn’t apply if you have stopped working for your former employer in or after the year you reached age 55, but not yet 59 ½.)

How the rollover is done is very important

Whether you pick an IRA for your rollover or your new employer’s plan, consider a direct rollover. This is when one financial institution sends a check directly to the other financial institution. The check would be made out to the bank or brokerage firm with instructions on how to roll the money into your 401(k)/IRA. 

An alternative is, having a check made payable to you, is not a good option. If the check is made payable directly to you, your employer must withhold 20% for taxes, which is required by the IRS. If that isn’t bad enough, you only have 60 days from the time of a withdrawal to put the money back into a tax-advantaged account like a 401(k) or IRA. This means if you want the full value of your former account to stay in the tax-advantage confines of a retirement account, you’d have to get the 20% that was withheld and put it into your new account.

If you cannot make up the 20%, you will lose the potential tax-free/tax-deferred growth on that money and owe a 10% penalty if you’re under age 59 ½ because the IRS would consider the tax withholding an early withdrawal from your account. 

 

The best decision

When it comes to deciding what to do with an old 401(k), there are many factors that apply to your specific situation. That means the best choice is different for everyone.