Many people who quit their jobs are faced with the issue of what to do with their 401(k) account. Individuals who have a 401(k) account from a prior employer have four options.2
Option 1: Leave it with your previous employer.
You can choose to do nothing and keep your 401(k) account with your old employer. If your account balance falls below a specific threshold, your ex-employer may choose to release the cash to you.
There may be compelling reasons to preserve your 401(k) with your former company, such as low-cost investments or limited access outside of the plan. Other considerations include preserving some creditor protections that are specific to qualified retirement plans, as well as the ability to borrow from it if the plan permits ex-employees to take out loans. 3
The main disadvantage is that people may lose touch with their old account and pay less attention to the ongoing administration of their finances.
Option 2: Join your new employer's 401(k) plan.
If your current employer's 401(k) allows you to transfer assets from another 401(k), you might want to consider doing so.
The simplicity of pooling your assets, retaining their strong creditor protections, and making them available via the plan's loan provision are the primary benefits of moving.
Many people decide to transfer their account and end their relationship with their prior company if the new plan offers a competitive investment menu.
Option 3: Invest in a Traditional Individual Retirement Account (IRA)
Another option is to roll assets into a standard IRA, whether it's a new or existing one. It's likely that a traditional IRA will offer investment options that your new 401(k) plan will not. 4
The disadvantages of this strategy could include a lack of creditor protection and the loss of access to these assets through a 401(k) loan provision.
Remember, don't feel compelled to make a decision right away. You have plenty of time to think about your options, and you may want to seek professional advice to answer any issues you may have.
Option 4: Take the money out of the account.
The final option is to just withdraw money from the account. If you choose to cash out, however, you may be subject to ordinary income tax on the balance as well as a 10% early withdrawal penalty if you are under the age of 59 1/2. Employers may also keep up to 20% of your account balance in order to prepay the taxes you'll owe.
Before you decide to cash out a retirement plan, think twice. Aside from the penalty for taking money out of an account that may potentially grow tax-deferred, there's also the opportunity cost of taking money out of an account that could potentially grow tax-deferred. Taking $10,000 out of a 401(k) instead of rolling it over into an account earning an average of 8% in tax-deferred profits over 30 years, for example, might leave you $100,000 short. 5
If you have questions about retirement planning or need help deciding what to do with your 401(k), contact us today.
1. Under the SECURE Act, in most circumstances, you must begin taking required minimum distributions from your 401(k) or other defined contribution plan in the year you turn 72. Withdrawals from your 401(k) or other defined contribution plans are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty.
2. FINRA.org, 2021
3. A 401(k) loan not paid is deemed a distribution, subject to income taxes and a 10% tax penalty if the account owner is under 59½. If the account owner switches jobs or gets laid off, any outstanding 401(k) loan balance becomes due by the time the person files his or her federal tax return. Prior to the 2017 Tax Cuts and Jobs Act, employees typically had to repay loans within 60 days of departure or face potential tax consequences.
4. Under the SECURE Act, in most circumstances, once you reach age 72, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA). Withdrawals from Traditional IRAs are taxed as ordinary income and, if taken before age 59½, may be subject to a 10% federal income tax penalty. You may continue to contribute to a Traditional IRA past age 70½ under the SECURE Act as long as you meet the earned-income requirement.
5. This is a hypothetical example used for illustrative purposes only. It is not representative of any specific investment or combination of investments.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. 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. This material was developed and produced by FMG Suite to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. 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. Copyright 2021 FMG Suite.