Have you recently changed jobs or retired from your current employer? You may be wondering what you should do with your old employer retirement plan.
Former employees typically have four options for their old 401(K) or other employer retirement plan when they leave their job. The options may vary slightly depending on the type of plan and your former employer.
Option 1: Take a Lump Sum Distribution
For a traditional 401(K), your contributions are pre-tax and grow tax-deferred. The lump sum distribution will be fully taxable as ordinary income. Large lump sum distributions may even push you into a higher tax bracket. There may even be an early-withdrawal penalty if you are younger than age 55 when you take the distribution.
Option 2: Leave the Money in the Employer Plan
If you leave the money in your employer plan, it will continue to grow tax-deferred until you take cash distributions in the future. Cash distributions from a 401(k) plan are generally subject to required 20% federal tax withholding and the entire distribution is considered ordinary income. The benefit of keeping your money in the 401(k) plan is that it offers greater creditor protection than an IRA. Creditor protection for IRAs is limited to $1 Million and may vary depending on your state. 401(k)s can typically be kept open unless the employer decides to terminate the plan. In the event that occurs, you will be required to move your money elsewhere. You may also experience blackout periods if the plan is being amended or changed that will prevent access to withdrawals and rollovers to other plans. Other factors you should look at before making your decision are investment options and fees. 401(k) plans are often limited to 10-20 funds that may make it difficult to properly diversify your portfolio. You should also ask the 401(k) provider about their administration, trading, and fund fees as these are often not visible in your statements. 401(k) providers also offer only limited investor education and asset allocation advice, not comprehensive financial planning.
Option 3: Rollover to a new employer 401(K)
For job changers, you may have the option to rollover your 401(K) to your new employer’s plan. Like in option 2, you will want to review the plan details to determine what advantages or disadvantages you may encounter.
Option 4: Rollover to an IRA
Many choose to rollover old retirement plans to an IRA for consolidation purposes. IRAs have similar benefits to 401(K) plans in that your money will continue to grow tax-deferred and the direct rollover does not constitute a taxable event. The advantage of the IRA is that it provides more flexibility and control than the 401(k) plan. With IRAs, you have your pick of custodians to hold the account and a universe of investment options to choose from. Distributions from the IRA are taxable as ordinary income and it is typically recommended but not required that you withhold taxes at your anticipated tax rate. Distributions before age 59 ½ are subject to a 10% penalty tax. IRA rollovers can also simplify your required minimum distributions (RMD) when they start at age 70 ½. Consolidating old employer plans into one IRA means you only have to calculate and take one distribution. If you have multiple old 401(k) plans, as many people do, you will have to contact each plan for your RMD calculation and distribution options. IRAs also have the option to be converted to Roth IRAs if you prefer to realize the taxes today. Roth IRAs grow tax-free for the rest of your life and do not have RMDs. This option may be preferred for people who do not need RMDs for income and want to leave a tax-free inheritance to their heirs.
As you can see, there is much to consider when it comes to 401(k) assets. We recommend talking to a trusted financial advisor to provide you with education your options.
Before deciding whether to retain assets in a 401(k) or roll over to an IRA, an investor should consider various factors including, but not limited to, investment options, fees and expenses, services, withdrawal penalties, protection from creditors and legal judgments, required minimum distributions and possession of employer stock. Please view the Investor Alerts section of FINRA website for additional information.