Your company 401(k) plan helps you to build retirement savings through employer matching and tax-deferred investment growth. But when you leave the job to move on to another opportunity or retire, you need to decide what to do with the account balance. You could leave the money in the 401(k) plan, roll it over into an IRA, take it with you to your new employer's plan or cash out the account. Here's a look at which option might work best for you.
Leave the money in the 401(k) plan. Many retirement savers have the option to leave the money in a former employer's 401(k) plan. If you plan to leave the workforce before age 59 1/2, you may want to keep the assets in your workplace retirement plan. Most 401(k) plans allow penalty-free withdrawals for people who separated from the employer at age 55 or later. If you move the money to an IRA, you will typically need to wait until age 59 1/2 to avoid the early withdrawal penalty. Workplace retirement plans such as 401(k)s also have better creditor protections than IRAs, which could be important for retirees who are struggling with debt.
Remember to compare the fee structure of your 401(k) plan to the costs of a new employer's 401(k) plan or an IRA. If your current plan custodian is a low-cost provider, the pricing may make a compelling case to stay put. However, if you have a high cost plan with excessive fees and other administrative costs, you may need to look elsewhere.
In addition to ensuring that the investment offerings are low cost, you should determine whether your choices provide enough diversification opportunities. You might want to go beyond stocks, bonds and cash and diversify into additional asset classes such as international and real estate funds. You may also want access to low-cost index funds such as those that track the S&P 500 that will help drive costs down and ensure you participate in future market growth.
[Read: 5 New 401(k) and IRA Rules for 2017.]
Move your money to your new employer's plan. If leaving the money with your previous employer does not make sense, consider whether your new employer's plan is any better. Check whether your new job offers a plan with low costs and fees, diversified investment options, access to index funds and better reporting and planning tools. Your decision is easy if you get to leave an expensive 401(k) plan and your new employer offers a well-designed retirement plan. An added benefit of rolling into another employer retirement plan is you retain the creditor protection.
Roll over to an IRA. If you won't need access to the money in your retirement account before age 59 1/2 and don't require creditor protection, consider rolling over your 401(k) account balance to an IRA when you change jobs. IRAs generally provide more account control and investment choices than 401(k) plans. You determine where the money is held and can choose a low-cost custodian to hold and invest your money. You no longer have to deal with your previous employer's human resources department every time you need to take a distribution, make a change to your account or update a beneficiary designation.
Over your career, you may participate in several 401(k) plans with different employers. You can consolidate all of your 401(k) plans into a single IRA, which will make it easier to track and manage your retirement savings. Fewer accounts will also make it easier to calculate your required distributions after age 70 1/2.
Cash out. There are very few reasons to take the cash and run. When you cash out your retirement accounts you will create a tax bill and remove the potential of those assets to keep working for you. For those younger than 59 1/2, in addition to the taxes generated at ordinary tax rates, the distribution will be subject to a 10 percent early withdrawal penalty. This might lead to a domino effect where more money is pulled from retirement accounts to cover the additional taxes due in April. The better choice is to continue to let these assets work for you and defer their use until you truly need them in retirement.
Changing jobs or retiring is a major life event. It is important to make sure you know all the factors that are impacted by this change. Retirement assets are often overlooked because of the excitement of moving on to a new life adventure. However, keeping tabs on your retirement savings is essential in order to minimize taxes and keep your money growing for the future.
Brian Preston and Bo Hanson are fee-only financial planners who host the podcast, "The Money-Guy Show".
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