What to do with an old employer’s sponsored plan, such as a 401(k), 403(b), Thrift Savings Plan (TSP) or SEP IRA, when you leave your employer, or retire can be a complex decision. As you consider your options, keep in mind that one of the greatest advantages of an employer sponsored retirement plan is that it allows you to save for retirement on a tax-deferred or tax-free basis (Roth component of the plan). Whether you have a financial advisor, tax professional or manage your own investments, you have many factors to weigh. Also, each one of you has a unique set of circumstances and goals to consider when evaluating your options.
Should you stay or should you go…well, the first step is understanding your options when you have a triggering event - separation of service such as change of job, early or regular retirement and layoffs. Carefully consider the following choices:
- Keep your former employer’s plan. If you are changing employment, retiring or have been laid-off, typically, you may leave your retirement savings in your former employer’s plan where it will continue to grow tax deferred. If you are vested in your plan and your account balance is $5,000 or less, your former employer may require you to take your money out of the plan when you leave their employment. Today, most companies permit you to leave your account in place but you may want to check the company’s policy with your benefits department or the plan’s administrator. Keeping your former employer’s plan may be a good idea if you are happy with the investment selection or if you are planning to move it to your new employer and you have a waiting period to satisfy before you are eligible to participate in their plan.
- Transfer the old plan into your new employer’s plan. You can transfer your old employer’s plan into your new employer’s plan. This options lets you consolidate your 401(k)s, 403(b)s, TSPs or SEP IRAs into one account simplifying the management of your assets. Keep in mind that your investment options, fees and expenses vary from plan to plan which may have an impact on your choice to leave the plan with your former employer, move it to your current employer or roll it over into an IRA.
- Rollover old plan into an IRA. Rolling your former’s employer’s plan into an IRA also provides you the opportunity to consolidate your retirement accounts while continuing to benefit from tax deferred growth. Doing a direct rollover into an IRA will not trigger state or federal taxes. Also, take into account that your distributions options in an IRA, for beneficiary(ies) following your death, may be more flexible than options in your employer’s plan. If you have credit protection concerns, know that your employer’s plan may provide unlimited protection from creditors under federal law. IRAs have limited protection, under federal law, only in cases where bankruptcy is declared. Any creditor protection your IRA may receive outside of bankruptcy will depend on your state of residence.
- Cash out. You can “take your money and run.” While tempting, cashing out is almost never a good idea. Lump sum distributions may significantly reduce your retirement savings. Cashing out your retirement plan before age 59 ½ will subject you to state and federal taxes plus a 10% withdrawal penalty. If you are 59 ½ or older and your contributions were pretax dollars, know that you will incur both state and federal taxes but not the 10% withdrawal penalty.
When deciding on whether or not to transfer your employer plan, begin by familiarizing yourself with your transfer options mentioned above. Before finalizing your decision to rollover your plan into an IRA, weigh in some of the follow key factors that may impact your goals. According to the Employee Benefit Research Institute, the largest source of IRA contributions comes from employer sponsored retirement plans. The following are additional considerations you may want to keep in mind:
- Age matters. If you left your former employer during or after the year you reached the age of 55, you may be able to take penalty-free withdrawals from your employer’s sponsored plan (i.e. 401(k)). In other words, without the 10% penalty, for tax purposes the withdrawal will be considered taxable income for both state and federal taxes. However, if you left your former employer prior to the year you reached age 55, the age 55 withdrawal provision does not apply. Your withdrawals from the IRA before the age of 59 ½ could be considered taxable income and incur the 10% penalty, unless you can qualify for an exception to the penalty (IRS rule 72(t)). Please consult your financial advisor and/or tax professional before deciding on this strategy.
- Examine fees and expenses. Fees and expenses are important, however, they may not provide the full picture in a rollover decision. Consider both potential benefits of leaving your account with your previous employer, as well as, transferring your plan to an IRA. Costs you may incur in your previous employer’s plans are administrative costs (recordkeeping and compliance fees), investment related expenses, fees for services (access to a customer service representative) among others. In some cases, employers may pay for some or all of the plan’s administrative expenses. IRAs also have investment related expenses such as set-up fees, investment related expenses, sales loads, commissions, custodial fees and/or advisory fees. Before making a rollover decision know what your plan provides, and what you may be giving up or gaining by transferring your funds.
- Compare investment attributes. You may choose an IRA rollover because it offers a universe of almost unlimited investment options and provides you more control over your IRA account. In an IRA you can customize your investment choices in a variety of asset classes and sectors. By contrast employer’s plans typically offer a limited selection of investments choices. Among other factors included in the due diligence process employers today often include ways to limit the liability of the trustee. This may serve to limit your investment options.
- Evaluate the value of service. Some employers provide access to investment advice, planning tools, telephone help lines, educational materials and workshops. Similarly, an IRA provider may offer planning tools, telephone help lines, educational material and different levels of service - brokerage service, financial planning service and investment advice. Each individual has their own comfort level in how they decide on the type of service they need and whether they are willing to invest money, time and thought. When making financial decisions are you a do it yourself type of individual? Or are you the type of person that is willing to pay for specialized advice when making financial decisions? Consider…your retirement decisions today will drive the quality of your retirement years.
- Tax Implications of appreciated company stock in an employer plan Some of you may have a company retirement plan that provides you with a company stock investment option (where contributions are made by you and your employer). If the stock has appreciated significantly you may want to take your money and run instead of rolling it over to an IRA if the age 55 rule applies to you or you are 59 ½ or older. Here is why…If you roll it over into an IRA you will pay ordinary taxes when you begin taking distribution from your IRA. However, the IRS has a special tax rule (Net Unrealized Appreciation “NUA”) that allows you to take the distribution of the stock, pay regular taxes on the original cost of the stock and capital gain taxes on the appreciation of the stock at the time of withdrawal. Since this is a complex strategy, please consult your financial advisor or tax professional.
As you can see, there is much to consider in deciding to move your retirement nest egg or to just stay put. Take the time to weigh all of your options by looking at your financial goals holistically. The good news is that there are many resources at your disposal. So, do not hesitate to seek help from your financial and/or tax professional and do your research.