Changing Jobs? Know Your 401(k) Options
Workers are changing jobs more than ever. Today, the average person changes jobs 10-15 times during his or her career, according to the Bureau of Labor Statistics.
That means workers are often in a state of transition. Many people who leave jobs must consider what to do with their employer-sponsored 401(k) plans.
The plans, which have grown in popularity the past two decades, offer tax-deferred savings. Contributions are deducted directly from earnings, and many companies will match all or part of an employee’s contributions. In 2015, 54 million Americans were active 401(k) participants, according to Investment Companies Institute.
“Since the 1990s, we have seen more companies move away from offering defined-benefit retirement plans to 401(k) plans,” says Edward O’Gorman, chief investment officer for River Wealth Advisors in Harrisburg. “Today, there’s much more mobility in the workforce, and 401(k) plans recognize that.”
When employees who participate in 401(k) plans leave a company, they have four options, which are reviewed below:
Cash out. This is the least advised option because it has far more negative consequences than positive ones. Some advisers refer to this as “raiding the piggy bank.”
“We strongly discourage this option,” says Jennifer Reisinger, chief operations officer, River Wealth Advisors. “The only time we would recommend this option is if the person were in a dire situation, such as having lost their job and having few financial resources.”
Reisinger says there are a number of penalties if you cash out your 401(k) before age 59 1/2. You will be subject to a 10 percent federal early-withdrawal penalty, plus income taxes. Employers often hold 20 percent of the cash-out just to pay taxes. You could lose up to 30 percent of your withdrawal. This is a hefty price to pay.
“It’s important to remember why you started a 401(k),” stresses Reisinger. “The goals were to save money for retirement and receive some tax benefits. By cashing in, you negate those goals.”
As if the penalties weren’t enough, you also lose the potential future earnings of your money compounding in the 401(k). If you took $10,000 out of your 401(k) instead of rolling it over into an account generating 8 percent tax-deferred earnings, your retirement fund could end up more than $100,000 short after 30 years, according to the Financial Industry Regulatory Authority.
Leave it with your old employer. You are not required to roll over your 401(k). It’s important, however, that you compare your old employer-sponsored plan with your new employer’s.
“We recommend a side-by-side comparison,” says O’Gorman. “You should look at the plans’ costs, investment options, potential limitations, and other features.”
If your former employer’s plan has provided strong returns with reasonable fees, you may want to consider leaving your account behind. If you decide to leave your account behind, you still have the option to move it to your new 401(k) or to an IRA at any time.
Be aware, however, that you will no longer be able to contribute to the account. Check to see if there are any other limitations.
Roll it over to your new employer’s plan. Not all employers allow you to roll over a 401(k) from a previous employer. Check with your employer to find out. If so, compare the two plans. You may benefit from more investment choices, lower fees, and more flexibility with your new employer. Select the plan that best meets your needs.
“Rolling over your 401(k) consolidates your funds into one account,” says Reisinger. “It makes it easier to see and manage your funds. We encourage people to keep it simple.”
Roll it over into an IRA. When considering the option of keeping your 401(k) with your company or rolling it over to an IRA, you should consider cost and flexibility. The costs associated with a 401(k) can vary significantly. An IRA can cost less, particularly since most have little to no annual fees.
Most 401(k) plans offer limited investment options, with the average 401(k) plan offering 20 funds, according to Brightscope. An IRA typically provides numerous investment options.
A traditional IRA can be rolled over to a Roth IRA, which offers tax-free growth and tax-free withdrawals in retirement. O’Gorman recommends that a financial adviser help with the rollover since timing is essential.
The most common mistakes people make in regards to their 401(k) plans, according to Reisinger and O’Gorman, are: cashing in, doing nothing, and missing the 60-day deadline.
Reisinger says: “Cashing in tends to be shortsighted and filled with negatives. Doing nothing often leads to missing better investment opportunities that give you more choice, control, and convenience.”
O’Gorman adds: “The IRS gives you 60 days to complete your 401(k) rollover to another IRA or qualified plan. If you fail to complete the rollover within that time, the funds will be treated as ordinary income when it comes to tax time. That’s a costly penalty you want to avoid.”
There are a lot of investment options, and they can sometimes be confusing. Financial advisers have the expertise and experience to help investors better understand their options. They also can help you manage your personal finances and reach your financial goals.