The average person will hold 12 jobs in their lifetime. Gone are the days of spending your entire professional life with the same company.
Each time you change jobs, there is more to consider behind the scenes than just the new role. Mainly your retirement account!
An estimated 2.8 million 401k accounts with an average balance of $55,400 are abandoned annually. Don’t leave your hard-earned savings in the dust with your previous employer.
Before you ride off into the sunset to your new job, you must decide what to do with your existing 401k. Let’s dive into 4 things you can do with your 401k when you leave an employer.
Option 1: Leave Assets In Your Existing Plan
If you’re happy with your account and your investment options, you may be tempted to keep the status quo by maintaining your existing 401k. But, before you lean toward this option, you need to check with your previous employer about a few things.
First, do they allow you to maintain your account if you are no longer an employee? Typically, if you have more than $5,000 invested in your 401k, you should be able to keep it where it is. If it’s less, you may have to take action and transfer it to an alternate account. So make sure to check with your plan administrator to see if keeping your account is an option.
Another item to regard is your previous employer’s vesting schedule. When you think about retirement, you can consider “vesting” as a synonym for ownership. Your employer may have a threshold you must meet before you become fully “vested” in your retirement plan.
Why does this matter? To start, it’s important to remember that any funds you contribute to your 401k are yours from the get-go. If your employer also makes contributions via a match, it might be a different story. Typically, employers require an employee to have served a certain amount of time, like 5 years, before they are vested and can walk away with the money.
So you leave the company before becoming vested, and all those matching contributions might not be yours to keep.
Option 2: Move Your Old 401k Into A New Employer-Sponsored Plan
It’s your first week at your new job, and you’re going through all the paperwork about your insurance options, paid time off, promotion schedule, etc. You also see that your new employer offers a 401k plan. Awesome!
On the surface, there are a few reasons why rolling over your assets into your new employer’s plan might make sense for you.
- It’s easier to have all your funds in one place – i.e., tracking your retirement savings goals.
- The new plan may have lower fees.
- The new plan may offer more investment opportunities.
But there may be some red tape. The most significant is adhering to proper transfer rules. If you don’t follow these rules, you may have to pay taxes and penalties on the rollover. To avoid this, initiate a direct rollover from your previous employer to your new employer instead of taking the amount via a check.
Option 3: Roll Over Your Assets Into an IRA
An Individual Retirement Account (IRA) is another excellent option for your old 401k. Essentially, it’s a retirement savings account without an employer attached to it!
One of the benefits of opening an IRA is that they often have a broader range of investment options to choose from. In addition, it might also save you money because you can shop around for the right custodian to hold your account. You don’t have that kind of flexibility with an employer-sponsored account.
Within the IRA family, there are two options: the Traditional IRA and the Roth IRA.
IRA Crash Course
Let’s take a cruise through the two types of IRAs, what makes them unique, and how they can benefit you and your retirement savings goals (hint – the main difference is when and how they are taxed).
Like any retirement account, IRAs have contribution limits. In 2022, it’s $6,000 for those under 50 and $7,000 if you’re 50 or over. It’s important to note that this limit does not apply to any rollover contributions, so if your existing account balance is over the yearly limit, no worries.
Rolling Your 401k Into A Traditional IRA
With this account, the funds you contribute are tax deductible, meaning they lower your taxable income. The funds also grow tax-deferred. But, when you withdraw the funds in retirement, you’ll pay ordinary income tax.
Traditional IRAs also have required minimum distributions (RMDs). Once you turn 72, you must start drawing down the account even if you don’t need the money just yet.
But you don’t need to wait until 72 to access the money. You can tap the account without penalty if you’re at least 59.5 or do so for qualified expenses like education, first home, or medical costs.
Rolling Your 401k Into A Roth IRA
Roth IRAs operate differently. You contribute after-tax dollars, so you don’t receive an upfront tax benefit. But, once the funds are in the account, you don’t have to pay taxes on the growth or qualified distributions after you retire.
Something unique about Roth IRAs is that they have income limits that determine if you can directly contribute—see where you fall on the spectrum here.
High-income earners can get around this rule by initiating a Roth conversion, where they convert money from a traditional account (like a 401k) into a Roth IRA. Be sure you work with your financial planner and tax professional before you do this, as you’ll have to pay taxes on the conversion.
You can make tax-free withdrawals from your Roth IRA once the account has been open for 5 years and you are at least 59 ½. Unlike the traditional IRA, a Roth IRA does not have any RMDs.
How Do I Know Which IRA Is Right For Me?
Both IRAs offer some sort of tax advantage. The right account for you is the one that fits your financial situation and will help push you toward your retirement savings goals.
A Traditional IRA might be right for you if:
- You have a traditional 401k account
- You won’t have to pay additional taxes because they have the same tax treatment
- Present tax savings is the most important
- You will likely stay in the same tax bracket throughout your life
- If you retire in a higher tax bracket, you might pay more taxes on withdrawals.
A Roth IRA might be right for you if:
- You’ve been contributing to a Roth 401k
- You won’t have to pay additional taxes because they have the same tax treatment.
- The tax bill won’t break the bank.
- You don’t want to have to worry about RMDs in the future.
It’s also important to note that Traditional and Roth IRAs aren’t mutually exclusive. You can have both! Doing this will add tax diversification to your portfolio while receiving the benefits of pre-tax and after-tax retirement accounts.
Option 4: Cash It Out
We get it, the idea of having extra cash on hand can be appealing. But, cashing out your 401k can have serious implications on the savings that you’ve worked so hard to accumulate. So, before you request that check, hear us out.
If you are under 59 ½, you will have to pay a 10% early withdrawal penalty in addition to regular income taxes on the entire distribution. This adds up fast!
On top of taxes and penalties, removing the funds early takes away the opportunity for them to grow and help you reach your savings goals. Ultimately, cashing out your 401k may push you backward in terms of reaching your retirement savings goals, even if it seems like a payday on the surface.
Where To Go From Here
If all this information makes your head spin, don’t worry!
Changing jobs can be stressful, and deciding the best way to maximize your old 401k is likely low on your priority list as you’re trying to close out of your role, make new connections, and understand your responsibilities.
It’s hard to navigate the ins and outs of making a retirement account transition. The worst-case scenario is that something gets lost in the shuffle, and you lose a chunk of your hard-earned savings.
Transitioning into a new work position is stressful enough, so let us guide you. Set up a time to chat with us today. We’re looking forward to the opportunity to help you take charge of your financial life and exceed your retirement savings goals.
Updated in September 2022
The contents of this article are for general information and educational purposes and should not be construed as specific investment, financial planning, tax, accounting, or legal advice. Please consult with a professional advisor before taking any action based on the contents of this article.
All investment and financial planning strategies involve risk of loss that you should be prepared to bear. We cannot guarantee any investment performance whatsoever, and past performance is not indicative of potential future returns.