Options for Your Old 401(k)
Here are 4 options if you still have a 401(k) with a former employer.
Changing or leaving a job can evoke a mix of emotions. It’s natural to feel excited about new opportunities while also experiencing some nervousness. If you’re retiring, this can be a significant transition as well. As you prepare to say farewell to your workplace, remember to take care of your 401(k) or 403(b) with that employer. You have several options available, and making an informed decision is crucial.
Since your 401(k) is likely a substantial part of your retirement savings, it’s essential to carefully consider the pros and cons of each option. Take the time to evaluate what works best for your financial future.
Consider these 4 options:
Keep your 401(k) at your former employer's plan
Many companies, though not all, permit you to maintain your 40l(k) savings in their plans even after you have departed.
Pros:
Your money has the chance to continue to grow tax-advantaged.
You can take penalty-free withdrawals if you left your former job at age 55 or older.
Many offer lower-cost or unique investment options.
Federal law provides broad protection against creditors.
Cons:
Depending on your old plan’s rules, if you have a low balance, your account may be sent to you as a taxable distribution, rolled over to an IRA, or rolled to your new 401(k).
If you choose to keep the money in your former employer's plan, you won't be able to add any more money to the account, or, in most cases, take a 401(k) loan.
Withdrawal options may be limited. For instance, you may not be able to take a partial withdrawal; you may have to take the entire balance.
After you reach age 73, you'll have to take annual required minimum distributions (RMDs). For those born 1960 or later, RMDs will start at age 75.
If you hold appreciated company stock in your workplace savings account, consider the potential impact of Net Unrealized Appreciation (NUA) before choosing between staying in the plan, taking the stock in kind, or rolling over the stock to an IRA. Keep in mind that rolling over the stock to an IRA will eliminate any NUA.
Roll over your 401(k) into an IRA
A Rollover IRA is a type of retirement account that enables you to transfer funds from your previous employer-sponsored retirement plan into an IRA. To set up your IRA, you’ll need to choose a financial institution. It's important to do some research on the fees and expenses associated with different IRA providers, as these can greatly differ and may impact your overall retirement savings. Lake Avenue Financial can help you when evaluating your options.
Pros:
Your pre-tax money has the chance to continue to grow tax-deferred.
If you're under age 59½, you can withdraw money penalty-free for a qualifying first-time home purchase or higher education expenses.
You may be able to get a broader range of investment choices than is available in an employer's plan.
Rolling over assets can be done by source type. This means you can roll over Roth assets independently to a Roth IRA.
Cons:
Investments may be more expensive than in your 401(k).
After you reach age 73, unless you were born in or after 1960, you’ll have to take annual required minimum distributions (RMDs) from a traditional IRA every year, even if you're still working.
Federal law offers more protection for money in 401(k) plans than in IRAs. However, some states offer certain creditor protection for IRAs too.
If you hold appreciated company stock in your workplace savings account, consider the potential impact of Net Unrealized Appreciation (NUA) before choosing between staying in the plan, taking the stock in kind, or rolling over the stock to an IRA or another employer's plan. Rolling over the stock into another tax-advantaged plan will eliminate any NUA.
If you're self-employed, you might have the opportunity to transfer funds from an old retirement plan into your own small business retirement plan, like a SEP IRA.
Transfer your old 401(k) into your new 401(k) plan
It’s important to keep in mind that not all employers will accept a rollover from your previous employer’s 401(k), so it’s recommended that you check with your new employer to see if this is an option for you.
Pros:
Your money has the chance to continue to grow tax-advantaged.
Consolidating your 401(k)s can make it easier to manage your retirement savings.
Many plans offer lower-cost investment options.
Federal law provides broad protection against creditors. You may be allowed to defer RMDs even if you're still working after age 73.
You can take penalty-free withdrawals if you leave your job with the new employer at age 55 or older.
Cons:
Make sure to understand your new plan rules. They may vary from your old plan.
Consider the range of investment options available in the new plan.
If you hold appreciated company stock in your workplace savings account, consider the potential impact of Net Unrealized Appreciation (NUA) before choosing between staying in the plan, taking the stock in kind, or rolling over the stock to an IRA or another employer's plan. Rolling over the stock into another tax-advantaged plan will eliminate any NUA.
If you're self-employed, you may also have the option to roll over your old 401(k) plan into your own small business retirement plan, such as a Solo 401(k).
Cash out your old 401(k)
Withdrawing funds from your 401(k) before reaching retirement age is generally not advisable unless it's absolutely necessary due to an urgent financial need and you have exhausted other options. The implications of such withdrawals can differ based on your age and tax circumstances. For example, if you take money out of your 401(k) before the age of 59½, you will typically face ordinary income taxes on the amount withdrawn, in addition to a possible 10% early withdrawal penalty. It's essential to carefully consider these consequences before making a decision.
If you leave your job with a former employer in or after the year you turn 55, you won’t face an early withdrawal penalty on your retirement account, even if you are under 59½. However, please note that this exception does not extend to funds that have been rolled over into an IRA or into other 401(k) accounts.
A $50,000 distribution before age 59½ could cost $20,500 in penalties and taxes
Source: Fidelity Investments (This example assumes a hypothetical 24% federal marginal income tax rate, a hypothetical 7% state income tax and a standard 10% penalty for early withdrawal. The penalty is not withheld from the distribution, but rather paid when the employee files their income taxes. This example is for illustrative purposes only.)
If you're under the age of 59½ and find yourself in an urgent need to access your funds, it's wise to withdraw only what you need for now. This approach allows you to preserve the bulk of your savings until you can explore other options for cash. Keep in mind that this is contingent upon your former employer permitting partial withdrawals. Alternatively, if you roll your account into an IRA or another 401(k), you may have the option to take a withdrawal later on.
Avoiding common rollover mistakes
When deciding between rolling over your retirement account into an IRA or your new employer's plan, think about opting for a direct rollover. In this process, one financial institution sends a check directly to the other, keeping things simple. The check will be made out to the new financial institution, with clear instructions to deposit the funds into your IRA or 401(k). This approach can help streamline your transition and ensure your retirement savings continue to grow.
Opting for a check made out to you might not be the best choice in this situation. When a check is issued directly to you, your plan administrator is required by the IRS to withhold 20% for taxes. This can complicate matters further, as you only have 60 days from the withdrawal to redeposit the funds into a tax-advantaged account, like a 401(k) or IRA. To maintain the full value of your former account within the tax-advantaged structure, you would need to cover the 20% withheld and contribute it to your new account.
If you're unable to come up with the 20%, you could miss out on the potential for tax-free or tax-deferred growth on that amount. Additionally, if you're under age 59½ (or under age 55 if you separate from your job this year or later), you might also face a 10% penalty. This is because the IRS treats tax withholding as an early withdrawal from your account. In summary, it's important to pay close attention to the details when rolling over your 401(k) to avoid any unnecessary penalties or lost growth opportunities.
Making the right decision for you
When considering what to do with an old 401(k), it’s important to think about your individual circumstances. Everyone's situation is different, so the right choice will vary for each person.
If you decide to roll your funds into another retirement account, make sure the investment mix is aligned to your risk tolerance and time horizon.
If you opt for an IRA specifically, your rollover money will sit in cash. This means you'll need to take an additional step in order to get invested.
Remember that the rules among retirement plans vary, so it's important to find out the rules your former employer has as well as the rules at your new employer.
Compare the fees and expenses associated with the accounts you're considering.
If you’re confused or overwhelmed after reading all this, Don’t worry, we’re here to help. Just reach out to Lake Avenue Financial and our financial planners will assist you with your decision.
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