It has likely happened to all of us. We leave a job in search of greener pastures and in the process leave an old 401(k) behind. 401(k) plans are a great way to accumulate wealth while working for an employer especially if that employer offers a matching or profit-sharing contribution. However, what are your options for your 401(k) balance once you leave the company and are no longer receiving those additional employer contributions? Well, fortunately for you, you have options!
- Leave it in the old plan
In most situations, it is perfectly acceptable to leave your 401(k) balance in the plan with your old employer. While there are some situations where an account with a very low balance will be closed (by way of sending you a check), a plan is normally perfectly happy to continue managing your money. If you decide to leave your money in the plan you will continue to be charged the applicable fees of the plan and your investment options will be restricted to those offered by the plan.
- Take it in cash
This is by far the least desirable option yet still worth mentioning. You do have the ability to take your 401(k) balance in cash once you leave an employer. The drawbacks to this option can be significant especially if you are younger than age 59 ½ . Because money invested in a 401(k) is invested pretax, you will be taxed on the entire portion that you withdraw from the 401(k). In addition, if you are younger than 59 ½ , the IRS will also assess a 10% penalty. For example, if you are in the 22% tax bracket and 40 years old, your withdrawal would be reduced by 32%. On top of that, some states mandate withholding of state income tax at the time of distribution which could add an additional 4 – 5%, or more, depending on your state. If you have been working for a company for a long time and have been diligent about investing, this could be a large hit to your retirement savings.
- Roll it into your new plan
If your new employer has a 401(k) plan, you have the option to roll your balance to the new plan. With this option, you will not be taxed or penalized however you will be assessed the fees applicable to that 401(k). Your investment options will also be restricted to those offered by the new plan. This option also allows you to consolidate your retirement savings and continue contributing to your account by way of payroll deduction.
- Roll over your account to an IRA
Of all the options mentioned, this one offers the most flexibility. Like a 401(k), a traditional IRA is funded with pretax dollars. This means that when you rollover your account balance you will not be charged taxes or penalties much like if you were to roll it into a new 401(k) plan. Unlike the 401(k), your investment options are not confined to a list of approved investments or a single fund company. You have significantly more flexibility in selecting funds or other investments that meet your needs for growth and risk tolerance. This option is best utilized when you have a financial advisor who can assist you in researching and selecting investments that will best serve your needs. In certain situations, you may be able to set up contributions by way of payroll deduction, but it is more common to contribute to an IRA by bank account transfer or check.
I apologize for the lack of a blog post last week; I was a bit preoccupied with the birth of my daughter who has assumed the role of CCO (Chief Cuteness Officer) at Provisio. That said, this week’s song is in celebration of Lucy’s arrival and the return of this blog (also a song from my high school days). Enjoy!
This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.